T.Y.B.B.I.

INTRODUCTION

Investment banks create securities, including stocks and bonds,

for themselves and other companies, and facilitate the trade in them.
They also help companies manage mergers and acquisitions. The
primary role of investment banking in the economy has traditionally
been to help businesses raise capital for their operations by selling
investment securities to the general public.
At a very macro level, ‘Investment Banking’ as the term suggests,
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). As we know,
banking & financial institutions on the one hand and capital market on
the other are the two broad platforms of institutional intermediation for
capital flows in the economy. Therefore, it could be inferred that
investment banks are those institutions that are the counterparts of banks
in the capital market in the function of intermediation in resource
allocation. Nevertheless, it would be unfair to conclude so, as that
would confine investment banking to a very narrow sphere of its
activities in the modern world of high finance. Over the decades, backed
by evolution and also fuelled by recent technological developments,
investment banking has transformed repeatedly to suit the needs of the
finance community and thus become one of the most vibrant and
exciting segment of financial services. Investment bankers have also
enjoyed celebrity status, but at times, they have paid the price for
excessive flamboyance as well.

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To continue from the above, in words of John F. Marshall and

M.E. Ellis, ‘investment banking is what investment banks do.’ This
definition can be explained in the context of how investment banks have
evolved in their functionality and how history and regulatory
intervention have shaped such an evolution. Much of investment
banking in its present form thus owes its origins to the financial markets
in USA, due to which, American investment banks have been leaders in
the American and Euro markets as well. Therefore, the term ‘investment
banking’ can arguably be said to be of American origin. Their
counterparts in UK were termed as ‘merchant banks’ since they had
confined themselves to capital market intermediation until the US
investment banks entered the UK and European markets and extended
the scope of such businesses.
Investment Banking is a system under which banks arrange long-
term funds for business and industry. They work both as financiers as
well as underwriters. As financiers they themselves provide long-term
funds to business and industry. As underwriters they work as middlemen
between Business Corporation and investors. They undertake the
responsibility of selling shares or debentures of the corporation to the
general public for commission. In the absence of failure of the public to
subscribe in full, they take the unsubscribed portion of the shares or
debentures underwritten by them.
The system such banking was first developed in Germany in the
middle of the nineteenth century. A number of investment banks were
established in Germany after 1853 for promoting industrial development
mainly because of two reasons:
1) Germany did not have adequate capital for its industrial
development. .

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2) Even persons who had the capital were afraid of investing

directly in industry for fear of loss. Such a tendency
amongst masses required development of banking
institutions which could raise the money from the public
and lend for long periods to industry for meeting their
development requirements.

The Investment Banking in India proved important agencies for

mobilizing savings of small masses in rural as well as urban areas. With
a view to make a proper assessment of the investment banks operating
in India, a detailed study is necessary of leading investment banks
engaged in mobilization of saving and investment.

The increasing sophistication and deepening of the financial

markets on one hand, and fast transforming corporate landscape from a
protective background to a globalised market place on the other, would
lead to more complex corporate transactions, and therefore the role of
investment bankers as transaction experts and advisers would become
dispensable.

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MEANING OF INVESTMENT BANKING

Investment banks, informally i-banks, assist public and private

corporations in raising funds in the capital markets (both equity and
debt), as well as in providing strategic advisory services for mergers,
acquisitions and other types of financial transactions. They also act as
intermediaries in trading for clients. Investment banks differ from
commercial banks, which take deposits and make commercial and retail
loans. In recent years, however, the lines between the two types of
structures have blurred, especially as commercial banks have offered
more investment banking services. In the US, the Glass-Steagall Act,
initially created in the wake of the Stock Market Crash of 1929,
prohibited banks from both accepting deposits and underwriting
securities; Glass-Seagull was repealed by the Gramm-Leach-Bliley Act
in 1998. Investment banks may also differ from brokerages, which in
general assist in the purchase and sale of stocks, bonds, and mutual
funds. However some firms operate as both brokerages and investment
banks; this includes some of the best known financial services firms in
the world.
There appears to be considerable confusion today about what
does and does not constitute an "investment bank" and "investment
banker". In the strictest definition, investment banking is the raising of
funds; both in debt and equity, and the name of the division handling
this in an investment bank is often called the "Investment Banking
Division" (IBD). However, only a few small boutique firms solely
provide this - such as Greenhill, with almost all investment banks
heavily involved in providing additional financial services for clients
such as the trading of fixed income, foreign exchange, commodity and
equity securities. It is therefore acceptable to refer to both the
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"Investment Banking Division" and other 'front office' divisions such as

"Fixed Income" as part of " investment banking" and any employee
involved in either side an "investment banker".
More commonly used today to characterize what was traditionally
termed "investment banking" is “sell side". This is trading securities for
cash or securities (i.e., facilitating transactions, market making), or the
promotion of securities (i.e. underwriting, research, etc.).
The "buy side" constitutes the pension funds, mutual funds, hedge
funds, and the investing public who consume the products and services
of the sell side in order to maximize their return on investment. Some
firms have both buy and sell side components.

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THE INDIAN SCENARIO

Growth
Merchant banking in India was given a shot in the arm with the
advent of SEBI in 1988 and the subsequent introduction of free pricing
of primary market equity issues in 1992. However, post – 1992, the
merchant banking industry was largely driven by issue management
activity which fluctuated with the trends in the primary market. There
have been phases of hectic activity followed by a severe setback in
business. SEBI started to regulate the merchant banking activity in 1992
and a majority of the merchant bankers who registered with SEBI were
either in issue management or associated activity such as underwriting
or advisorship. SEBI had four categories of merchant bankers with
varying eligibility criteria based on their net worth. The highest number
of registered merchant bankers with SEBI was seen in the mid-nineties,
but the numbers have dwindled since, due to the inactivity in the
primary market. The number of registered merchant bankers with SEBI
as at the end of March 2003 was 124, from a peak of almost a thousand
in the nineties. In the financial year 2002-03 itself, the number
decreased by 21.

Constraints in Investment Banking

Due to the over – dependence on issue management activity in
the initial years, most merchant banks perished in the primary market
downturn that followed later. In order to stabilize their businesses,
several merchant banks diversified to offer a broader spectrum of capital
market services. However, other than a few industry leaders, the other
merchant banks have not been able to transform themselves into full
service investment banks. Going by the service portfolio of the leading
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full service investment banks in India, it may be said that the industry in
India has been more or less similar development as its western
counterparts, though the breadth available in the overseas capital market
is still not present in the Indian capital market. Secondly, due to the lack
of institutional financing in a big way to fund capital market activity, it
is only the bigger industry players who are in investment banking. The
third major deterrent has also been the lack of depth in the secondary
market, especially in the corporate debt segment.

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ROLE OF THE INVESTMENT BANK

Investment banks provide four primary types of services: raising

capital, advising in mergers and acquisitions, executing securities sales
and trading, and performing general advisory services. Most of the
major Wall Street firms are active in each of these categories. Smaller
investment banks may specialize in two or three of these categories.

Raising Capital
An investment bank can assist a firm in raising funds to achieve a
variety of objectives, such as to acquire another company, reduce its
debt load, expand existing operations, or for specific project financing.
Capital can include some combination of debt, common equity,
preferred equity, and hybrid securities such as convertible debt or debt
with warrants. Although many people associate raising capital with
public stock offerings, a great deal of capital is actually raised through
private placements with institutions, specialized investment funds, and
private individuals. The investment bank will work with the client to
structure the transaction to meet specific objectives while being
attractive to investors.

Mergers and Acquisitions

Investment banks often represent firms in mergers, acquisitions,
and divestitures. Example projects include the acquisition of a specific
firm, the sale of a company or a subsidiary of the company, and
assistance in identifying, structuring, and executing a merger or joint
venture. In each case, the investment bank should provide a thorough
analysis of the entity bought or sold, as well as a valuation range and
recommended structure.

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Sales and Trading

These services are primarily relevant only to publicly traded
firms, or firms which plan to go public in the near future. Specific
functions include making a market in a stock, placing new offerings,
and publishing research reports.

General Advisory Services

Advisory services include assignments such as strategic planning,
business valuations, assisting in financial restructurings, and providing
an opinion as to the fairness of a proposed transaction.

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FUNCTIONS OF INVESTMENT BANKING

Investment banks in countries like Australia, the UK or US

typically have corporate finance, capital markets, trading, institutional
equity and fixed income, private clients advisory, derivatives,
compliance and research departments as well as other major functions
like project finance, structured finance, investment management and
mergers and acquisitions.

Increasingly, investment banking is migrating in two distinctly

different directions: one, the tendency for global banking entities to
merge and grow larger to reap the global scale economies created by
falling capital controls; and two, the emergence of small niche industry,
technology or regional entities that fulfill specialist tasks.

For major investment banks the key areas are corporate finance
which involves designing financing proposals such as IPO’s or
structured financings; institutional equity departments which market the
proposals or IPO’s (sometimes called primary offerings); and research
which provide the detailed analysis and information on companies for
corporate finance and institutional equity to market to their respective
clients: the companies supplying equity and the institutions demanding
equity.

For smaller specialist players it is increasingly the provision of

specialist quantitative, technology or customized knowledge capital that
is key.

Those investment banks that also run investment management

businesses and stock broking businesses have to be careful to maintain
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strict “firewalls” with their corporate finance arms to ensure that price
sensitive information does not reach these parts of the business before it
is announced to the market as a whole. In practice, this requires
investment banking managements to require keen compliance to ethical
and regulatory codes of conduct to avoid conflicts of interest, a source
of constant challenge to the industry.

Investment bankers perform the following four basic economic functions:

1) Arrange the provision of capital for corporations and
governments by underwriting and distributing new issues of
securities;
2) Maintain markets in securities by trading and executing orders in
secondary market transactions;
3) Provide advice on the issuance, purchase, and sale of securities,
and on other financial matters.
4) Create and manage collective investment vehicles

In contrast to commercial banks, whose chief functions are to

accept deposits and grant short-term loans to businesses and consumers,
investment bankers engage primarily in long-term financing.

They also solicit new untapped funds from large institutions and
wealthy individuals on a case by case basis to finance transactions they
arrange, instead of drawing on the existing pool of funds from
commercial banks.

Underwriting
When a company needs financing to expand or undertake new
projects in many countries today, an investment bank will step in to
offer advice on possible methods and sources of funding.

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Sometimes the investment bank will offer to buy the entire issue
and resell the securities in smaller amounts to investors, a procedure
known as 'firm commitment' underwriting. At other times the
investment bank will offer to act on a "best efforts" basis for
commission only, or sometimes in a mixture of the two.

The method chosen will depend on the nature of the firm and
industry, the reason for the financing, the size of the issue and the state
of capital market supply and demand. Often before deciding on the
mechanism the investment bank will work alongside other financial
advisers, such as accountants and lawyers, to analyses the issuers’
circumstances and strategy in order to design the optimal financing mix
to fit this strategy.

Interaction with Institutions

The investors to whom these issues are marketed include
individuals, insurance companies, pension funds, trust companies,
investment companies, and other financial institutions. Investment
banks are therefore careful to work closely with financial institutions to
gauge the level of their demand and interest for current or other issues.

At other times an investment bank may offer to help a corporate

issuer sell an entire issue of securities directly to one or more
institutional buyers, such as insurance companies, without registering
the issue for public sale. These sales are known as private placements.

Syndication
Large issues are usually underwritten by syndicates or groups of
firms in order to share the risk. The “originating” investment bank that

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proposes and designs the financing mix is usually named as the lead
manager of the issue.

The lead manager conducts a thorough investigation of the

issuing corporation, analyzing financial, marketing, and production
matters involved in the proposed transaction. It then enlists the
participation of other houses in a syndicate; each syndicate member
agrees to take a specified part of the issue.

At this point it is worth distinguishing between two slightly

different approaches to the issuing and underwriting process used in the
UK and Australasia on the one hand and in the US and Canada on the
other.

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MAIN ACTIVITIES AND UNITS OF

INVESTMENT BANK

Large, global investment banks typically have several business

units, including Investment Banking, concerned with advising public
and private corporations; Research, concerned with producing reports
on valuations of financial products; and Sales and Trading, concerned
with buying and selling products both on behalf of the bank's clients and
also for the bank itself. Banks undertake risk through Proprietary
Trading, done by a special set of traders who do not interface with
clients and through Principal Risk, risk undertaken by a trader after he
buys or sells a product to a client and does not hedge his total exposure.
Banks seek to maximize profitability for a given amount of risk on their
balance sheet.

Investment Bank

Front Office Middle Office Back Office

An investment bank is split into the so-called Front Office,

Middle Office and Back Office. The individual activities are described
below:

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FRONT OFFICE
 Investment Banking is the traditional aspect of investment banks

which involves helping customers raise funds in the Capital Markets

and advising on mergers and acquisitions. Investment bankers
prepare idea pitches that they bring to meetings with their clients,
with the expectation that their effort will be rewarded with a mandate
when the client is ready to undertake a transaction. Once mandated,
an investment bank is responsible for preparing all materials
necessary for the transaction as well as the execution of the deal,
which may involve subscribing investors to a security issuance,
coordinating with bidders, or negotiating with a merger target. Other
terms for the Investment Banking Division include Mergers &
Acquisitions (M&A) and Corporate Finance.
 Financial Markets is split into four key divisions: Sales, Trading,

Research and Structuring.

 Sales and Trading is often the most profitable area of an
investment bank, responsible for the majority of revenue of
most investment banks. In the process of market making,
traders will buy and sell financial products with the goal of
making an incremental amount of money on each trade. Sales
is the term for the investment banks sales force, whose
primary job is to call on institutional and high-net-worth
investors to suggest trading ideas (on caveat emptor basis) and
take orders. Sales desks then communicate their clients' orders
to the appropriate trading desks, who can price and execute
trades, or structure new products that fit a specific need.
 Research, is the division which reviews companies and writes
reports about their prospects, often with "buy" or "sell"
ratings. While the research division generates no revenue, its
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resources are used to assist traders in trading, the sales force in

suggesting ideas to customers, and investment bankers by
covering their clients. In recent years the relationship between
investment banking and research has become highly regulated,
reducing its importance to the investment bank.
 Structuring has been a relatively recent division as
derivatives have come into play, with highly technical and
numerate employees working on creating complex structured
products which typically offer much greater margins and
returns than underlying cash securities.

MIDDLE OFFICE
 Risk Management involves analysing the risk that traders are

taking onto the balance sheet in conducting their daily trades, and
setting limits on the amount of capital that they are able to trade
in order to prevent 'bad' trades having a detrimental effect to a
desk overall.

BACK OFFICE
 Operations involve data-checking trades that have been
conducted, ensuring that they are not erroneous, and transacting
the required transfers. Whilst it provides the greatest job security
of divisions within an investment bank, it is widely known to
involve the most monotonous work at relatively low pay.
 Technology - Every major investment bank has considerable

amounts of in-house software, created by the Technology team,

who are also responsible for Computer and Telecommunications.

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RISK IN INVESTMENT BANKING

Risk is defined as the volatility or standard deviation (the square

root of the variance) of net cash flows of the firm, or, if the company is
very large, a unit within it. In a profit – maximizing bank, a unit could
be a whole bank, a branch, or, a division. The risk may also be
measured in terms of different financial products. But the objective of
the investment bank as a whole will be to add value to the bank’s equity
by maximizing the risk – adjusted return to shareholders. In this sense, a
bank is like any other business, but for banks, profit ability (and
shareholder value added) is going to depend on the management of
risks. In the extreme, inadequate risk management may threaten the
solvency of bank, where insolvency is defined as a negative net worth,
that is, and liabilities in excess of assets.

Credit Risk
Credit risk is the risk that an asset or a loan becomes
irrecoverable in the case of outright default, or the risk of delay in the
servicing of the loan. In either case, the present value of the asset
declines, thereby undermining the solvency of a bank. If the agreement
is a financial contract between two parties, counterparty risk is the risk
that the counterparty reneges on the terms of the contract. The term
counterparty risk is normally used in the context of traded financial
instruments, whereas credit risk refers to the probability of default on a
loan agreement.

Liquidity and Funding Risk

This is the risk of insufficient liquidity for normal operating
requirements, that is, the ability of the bank to meet its liabilities when
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they fall due. The problem arises because of a shortage of liquid assets
or because the bank is unable to raise cash on the retail or wholesale
markets. Funding risk is the risk that a bank is unable to fund its day-to-
day operations.

Liquidity is an important service offered by investment bank.

Customers place their deposits with a bank, confident they can
withdraw the deposit when they wish. If the ability of the bank to pay
out on demand is questioned, all its business may be lost overnight.
Since the bank can do nothing to reduce its overhead costs during such a
short period, it will incur losses and could become insolvent.

Maturity matching will guarantee liquidity and eliminate funding

risk because all deposits are invested in assets of identical maturities:
then every deposit can be met from the cash inflow of maturing assets.
But such a policy will never be adopted because intermediation in the
form of asset transformation is a key source of bank profit.

Interest Rate Risk

Interest rate risk arises from interest rate mismatches in both the
volume and maturity of interest – sensitive assets, liabilities, and off-
balance sheet items. An unanticipated movement in interest rates can
seriously affect the profitability of the bank, and therefore, shareholder
value added. The traditional focus of an asset liability management
group within a bank is the management of interest rate risk.

Bank can lend at either fixed or variable rates, here the variable
rate is linked to some central base or bank rate. Banks will always have
some interest mismatch, such as a mismatch between fixed and variable
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rate assets and liabilities. If they have excess fixed rate liabilities, they
are vulnerable to failing rates. Banks may be either asset sensitive,
meaning their interest sensitive assets reprice faster than their interest
sensitive liabilities, or liability sensitive, where the opposite is the case.
Typically, the former is the norm, meaning a fall in interest rates will
reduce net interest income by increasing the bank’s cost of funds
relative to its yield on assets. If a bank is liability sensitive, a rise in
rates will reduce net income.

Market or Price Risk

Banks incur market (or price) risk on instruments traded in well –
defined markets. The value of any instrument will be a function of price,
coupon, coupon frequency, time, interest rate, and other factors. If a
bank is holding instruments on account (for example, equities, bonds),
then it is exposed to price or market risk, the risk that the price of the
instrument will be volatile. General or systematic market risk is caused
by a movement in the prices of all market instruments because of, for
example, a change in economic policy. Unsystematic or specific market
risk arises in situations where the price of one instrument moves out of
line with other similar instruments, because of an event (or event)
related to the issuer of the instrument. Thus the announcement of an
unexpectedly large government fiscal deficit might cause a drop in a
general share price index, while the announcement of an environmental
law suit against a firm will reduce its share price, but is unlikely to
cause a general decline in the index.

A bank can be exposed to market risk (general or specific) in

relation to debt securities (fixed and floating rate debt instruments, such
as bonds) debt derivatives (forward rate agreements, futures and options

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on debt instruments, interest rate and cross country swaps, and forward
foreign exchange positions) equities, equity derivatives (equity swaps,
futures and options on equity indices, options on futures, warrants), and
currency transactions.

Foreign Exchange or Currency Risk

Under flexible exchange rates, any net short or long open position
in a given currency will expose the bank to foreign exchange risk, a
special type of market risk. A bank with global operations experiences
multiple currency exposures. The currency risk arises from adverse
exchange rate fluctuations, which affect the bank’s foreign exchange
positions taken on its account, or on behalf of its customers. Banks
engage in spot, forward and swap dealing. These banks have large
positions that change dramatically every minute. Mismatch currency
and by maturity is an essential feature of the business – successful
mismatch judgments may reflect successful risk management.

Sovereign and Political Risks

Sovereign risk normally refers to the risk that a government will
default on debt owed to a private bank. In this sense, it is a special form
of credit risk, but the bank may not have the usual tools for recovering
the debt at its disposal. For example, if a private debtor defaults, the
bank will normally take possession of assets pledged as collateral. But if
the defaulter is a sovereign government, the bank is unlikely to able to
recover the debt by taking over some of the country’s assets.

Political risk is the risk of political interference in the operations

of a private sector bank. It can range from banks being subjected to
interest rate or exchange control regulations, to nationalization of a
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bank. For example, since the Second World War, France has vacillated
between nationalisation and privatization of its banking sector. All
businesses are exposed to political risk but banks are particularly
vulnerable because of their critical position in the financial system.

Operating Risk
Operating risk is the risk associated with losses arising from fraud
or unexpected expenses such as for litigation. A good illustration of this
form of risk is the Hammersmith and Fulham Council case. This
London borough had taken out interest rate swaps in the period
December 1983 to February 1989. The swaps fell into two categories,
one for hedging and one for speculation. With local taxpayers facing a
bill of tens of millions of pounds, the House of Lords (in 1991) declared
all the contracts null and void, overturning an earlier decision by the
appeal court. Barclays, Chemical, the Midland, Mitsubishi Finance
International and Security Pacific were the key banks left facing £400
million in losses and 15 million in legal fees.

Risk of Global Banking

Global diversification of assets often allows a bank to improve
upon its risk management, thereby raising profitability and shareholder
value added. However, global exposure makes the business of risk
management more complex, for a number of reasons. First, banks with
branches or subsidiaries in other countries have part of their
infrastructure exposed to currency, exchange control, and political risk.
Second, evaluating credit risks in foreign countries requires additional
research and intelligence. Third, the interbank and Euromarkets are
vulnerable to any unexpected financial shocks arising from key players
in these markets, such as Japan or the USA. Fourth, sovereign risk may

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be a greater threat in the institutional arena, if political default in foreign

countries is more common than in the home country. Finally, fraud or
financial mismanagement is harder to defect in international operations,
thereby increasing operating risk.

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The Golden Years of Investment Banking

A quick historical review of investment banks will serve as a backdrop to the

events that led to their downfall.

Independent investment banks have been around for a long time, but originally
they were small private partnerships that earned most of their money from
offering corporate finance and investment advice, as well as some broking and
other services. If you had walked into one of their offices and looked around,
you might have mistaken it for a large law firm.

The success of their business model depended on the trust built through long-
term relationships. There wasn't much money at risk in the early days because
the firms operated primarily with the partners' own money. That meant there
weren't vast sums available to gamble on risky ventures with excessive
leverage. But the lack of working capital and a desire to orchestrate splashier
deals, motivated the firms to go public in the late 90s.

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Types of Investment Banking

When you talk about investment and investment banking, the first thing that
would come to your mind is business management and finance. An investment
is something that you place in a bank or venture in the hopes of either saving
the money or letting it grow. It is usually for the latter reason that individuals
and organizations transact investments. To understand investment banking,
first, we have to understand its roots. The term "invest" comes from the term
"vests," which is Latin for "garment" and was used to denote the act of putting
resources into another one's pockets. Like the Latin term, the investor puts the
assets into another entity's pocket; the latter is where the investment banks
come in.

Basically, investment banking involves the client purchasing assets from the
investment bank. The client expects that the purchased asset capital will gain
dividends and grow. In effect, the investor did not work on anything other than
making the initial purchase.

Generally, a bank is a financial institution. It is usually concerned with being

the middle entity from which the client can transact business. The client places
the money in the different forms of banking services and gains some interest
out of this input. The bank, in turn, invests the client's money into business
ventures or allows the clients to borrow money for interest in order to grow the
initial cash investment. On the other hand, investment banking is a specific
type of banking, which is transactions related and limited to the financial
market. This type of banking is concerned with investments as a whole.

Investment banks come in two types. The basic investment bank issues stocks
and bonds to the clients for a pre-specified amount. The bank then invests the
money that the client used to purchase the stocks and bonds. These
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investments differ among banks. In countries where it is allowed to do so,

investment banks have their networks of financial and lending institutions
from which they profit. Others also invest in property development and
construction. The client with the stocks and bonds would then receive
payments from the profits made on his money on a specified period of time. It
can be justified that both the client and the investment bank profited from the
client's initial investment. Because these banks know the ins and outs of their
trade, it is not unusual that small or large business ventures and corporations
seek their help on matters regarding mergers, acquisitions, and other corporate
activities.

The second type of investment banks is the merchant bank. These banks are
involved in trade financing and providing capital to business ventures not in
terms of loans but of shares. Because these investment banks are based on
security of the shares, they finance only those ventures that have made their
mark in the business world. New merchant companies are usually not
financed.

However, versatility is necessary in business. Therefore, a lot of banks have

evolved to encompass all aspects of banking to cater to the needs of a wide
range of customers. These banks offer savings deposits and loans services to
regular customers and, at the same time, offer investments to the financially
advanced ones.

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How Investment Banking Operations Differ From Other Banks?

Unlike commercial banks and savings and loans, investment banks do not seek
cash deposits from customers in the form of checking and savings accounts,
and they do not make traditional interest-bearing loans to individual
customers.
Investment banks instead make their money primarily
• By advising corporate clients on the creation of stocks, bonds and other
securities
• By underwriting securities
• By facilitating mergers and acquisitions, along with any due diligence
and securities exchanges that may go along with them.
• And by brokering (or selling) securities to investors.
Investment bankers have also created a broad array of investment options to
go along with traditional stocks and bonds, including securities derivatives
such as call and put options, which allow investors to lock in a buy or sell
price on an investment at a future date, and credit default swaps, which insure
bond buyers against the risk that a bond seller will renege on the debt.
Investment banks also lend stocks to facilitate short trades, in which
speculators borrow stock and sell it in hopes that its price will decline before
they re buy it and return it to the lender.

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T.Y.B.B.I.

Changes in Investment Banking

In 1933, Congress passed the Glass-Steagall Act, which separated key

investment banking functions from commercial banks. In the midst of the
Great Depression, lawmakers feared that combined investment and
commercial banking institutions would be tempted to use money in
commercial banking deposits, such as checking accounts, to bail out unwise
bets on the investment banking side if the two remained combined.
Glass-Steagall was effectively repealed in 1999 and, although commercial
banks and investment banks were once again given the leeway to combine
under one roof, pure investment banks enjoyed greater relief from government
regulations. In one notable case, the federal Securities and Exchange
Commission raised the debt limit for investment banks in 2004, which allowed
Wall Street’s largest pure investment banks, such as Merrill Lynch, Lehman
Brothers, Bear Stearns and Goldman Sachs, to invest more freely with
borrowed money – an option largely denied to commercial banks, who were
forced to maintain higher levels of cash and securities reserves to back up their
loans and investments.
The playing field shifted again in 2008, when a widespread financial crisis
forced all of the largest surviving Wall Street firms to convert themselves into
bank holding companies in order to gain eligibility for federal aid.
The move transferred the firms from the investment-oriented regulatory
oversight of the Securities and Exchange Commission to the commercial
banking-oriented regulation of the Federal Reserve, with consequences that
are still unclear.

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T.Y.B.B.I.

Investment Banking Conference

With times being hard these days, investment banking is a good way to invest
money and still feel secure. In this type of banking, an individual or a
company or the government seeks the assistance and guidance of an
investment bank to buy or sell securities. It is the investment banks that
address concerns on mergers of companies or acquisition of new properties.
They are also the experts in providing comprehensive advice to clients to
manage their capital and investments. They also help in risk management and
assessment.

To be able to serve their clients well, periodically, investment banking

conferences are held to keep the clients up-to-date with what measures the
banks are doing to protect the investments and at the same time how these
investments are faring in the ever-changing world of business and finance.
These conferences are also designed to build a holistic relationship between
the clients and the banks to be able to identify the needs and the
responsibilities of the clients as well as the corresponding responsibilities of
the banks.

These investment banking conferences are also done to provide a way for
various investment banks to help one another and share their expertise in
different fields to help augment the status of this type of banking and, at the
same time, find timely solutions to current problems targeting the banking
community.

The whole world is experiencing an alarming economic crisis. Because this

global crisis interconnects, various finance institutions are at a great risk.
Therefore, the investment banking conference aims to address common issues

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T.Y.B.B.I.

such as credit markets affecting the economy, corporate environments being

affected by constant changes, and investment banks that need to be kept
abreast with the fast events.

For an investment banking conference to be effective, it has to accept the fact

that banks could not stand by themselves. Therefore, client issues should be
addressed, and experts on various industrial fields should be allowed to share
the practical knowledge that they have learned. Also, the usefulness and
timeliness of academic research being done by renowned business researchers
should not be overlooked. Current issues will help understand and solve
current problems, and current trends will be useful to predict the future of the
financial world.

A good investment banking conference will allow all concerned sectors to

interact with one another and provide inputs to benefit all. The professional
inputs of industry experts along with the intellectual inputs from the academic
researchers can solve a lot of issues that may have been difficult for just one
team to solve.

Because important decision-making issues will be discussed, investment

banking conferences usually cater to CEOs and other top executives. The
presenters from various fields of industrial or academic expertise are also
renowned in their own right and at par with the CEOs in attendance. These
conferences therefore strengthen the networks that the financial market holds
over global issues and events.

During this difficult time of world crisis and poverty, the general banking
clients can still sit peacefully and trust that the investment banks will do their
best in finding solutions to solve current issues.

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T.Y.B.B.I.

GLOBAL INDUSTRY STRUCTURE

The investment banking industry on a global scale is oligopolistic

in nature ranging from the global lenders (known as ‘Global Bulge
Group’) to ‘Pure’ investment banks and ‘Boutique’ investment banks.
The bulge group consisting of eight investment banks has a global
presence and these firms dominate the league tables in key business
segments. The top ten global firms in terms of their fee billings as in
2001 are listed in following table.

% of
Banks
Total
Merrill Lynch 9.0
Goldman Sachs 7.5
Credit Suisse First Boston 7.2
Salomon Smith Barney (Citigroup) 6.7
Morgan Stanley 6.3
J. P. Morgan 5.5
UBS Warburg 4.6
Lehman Brothers 3.6
Deutsche Bank 3.5
Bank of America 2.4

Market Share of Global Investment Banks

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T.Y.B.B.I.

Within the listing given in the table referred to above are the top
‘Pure’ investment banks, i.e. which do not have commercial banking
connections, which are Merrill Lynch, Goldman Sachs and Morgan
Stanley Dean Witter; Listed therein are also the leading European
Universal banks that are called so due to their role in both commercial
and investment banking. The five leading universal banks in the world
and their important group affiliates are listed in the table below.

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T.Y.B.B.I.

J. P. UBS
Citigroup CSFB Deutsche
Morgan Warburg
(US) (Swiss) (German)
(US) (Swiss)
Deutsche J.P. Morgan UBS
Citibank CSFB
Bank Chase Warburg
Salmon
Donaldson, Chemical
Smith Barney Morgan
Lufkin & Bank Dillon Read
(Investment Grenfell
Jenrette (merged)
Bank)
Beacon Paine
Schroders Pershing Alex Brown
Group Webber
Bankers Robert Philips &
Trust Fleming Drew
Hambrecht & Swiss Bank
Quist (merged)
Universal Banks and their investment banking affiliates
Source:- scribe.com
Therefore, the global investment banking industry ranges from
the acknowledged global leaders listed above to a larger number of
mid-sized competition at a national or regional level and the rear end
is supported by boutique firms or advisory and Sectoral specialists.

INVESTMENT BANKING LEAGUE TABLES

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T.Y.B.B.I.

 Worldwide mergers and acquisitions: top five (1 January 1999-31

August 1999)

$bn
Goldman Sachs 675.6
Morgan Stanley Dean Witter (MSDW) 588.2
Merrill Lynch 552.9
Credit Suisse First Boston (CSFB) 388.5
Lehman Brothers 249.6

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T.Y.B.B.I.

Departments in Investment Banking

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T.Y.B.B.I.

1. Corporate Finance: Assists corporate clients to raise capital to finance

their operations and expansionary plans. Teams evaluate the needs of

the clients and assess the inclination of various capital Market.
2. Derivatives: Work with large clients who are exposed to risk of price

fluctuations in certain markets to structure products in order to ease

these risks.
3. Mergers & Acquisitions (M&A): One of the most revered departments

in I-banking. M&A provides advisory to companies in varying

industries who wish to acquire other companies or divest current assets.
4. Private Client Services (PCS): Also known as Wealth Management.

PCS builds relationships and networks with high net-worth individuals

and helps clients manage their financial portfolios.
5. Public Finance: Mainly deals with securities issued by governments.

These securities often have unique features and structured tax

implications and require substantial legal and public administration
cooperation.
6. Retail: Purchases and sells stocks, bonds, derivatives and other financial

instruments on behalf of small, individual clients.

7. Sales & Trading : Make trades in securities for the primary and

secondary markets for currencies, stocks, bonds, derivatives, futures,

commodities, asset-backed treasuries etc on behalf of institutional
clients (mutual and pension funds), individual investors and for the
banks themselves.

Failure of Investment Banking

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T.Y.B.B.I.

FINALLY THE era of investment banking has come to an end. Of the five
independent banks that existed at the start of this year, only two had remained.
And even these two big building blocks -- massive I-Bank structures have also
decided not to exist as independent Investment Banks on Wall Street.
Goldman Sachs and Morgan Stanley have finally concluded that there is no
future in investment banking.

Fall of the three biggies (Bear Sterns, Leman and Merrill Lynch) was drastic
in the I-banking world but Lehman Brothers case of filling of bankruptcy
under Chapter 11 of US Bankruptcy law was the most tragic among those who
finally closed shop. Now that the Federal Reserve Bank and the Central Bank
of America have given its approval for turning the two I-Banks (Goldman
Sachs & Morgan Stanley) into a deposit accepting bank this will mark an end
of over 75 years of era of investment banking which recently reached a
phenomenal growth from where probably there was no further ascent Finally
owing to the dilapidated condition Morgan Stanley will be sold to some banks
like Wachovia Corp while the stronger one Goldman Sachs is looking to
purchase some small commercial banks with big deposits.

Banking in US is primarily categorized into two groups, first group of banks

are deposit taking commercial banks and other groups are firms dealing in
securities popularly known as I-Banks. Federal Reserve Bank regulates
commercial banks whereas I-Banks come under the purview of Securities
Exchange Commission (SEC). So with the closure of the two last surviving
big I-banks the role of the SEC may become redundant in the US.

Investment banks were originally meant to help companies and government to

raise money by issuing and selling securities in the capital markets. Slowly the
investment banking raised its arms in the area of mergers and acquisitions by

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T.Y.B.B.I.

providing advice on the issue as consultants. The business of investment

banking, which was originally developed, on the softer business slowly turned
out to be more aggressive after the development of most complex derivatives
which they started selling and buying aggressively. Over time the taste of
trading in securities by utilizing the hedge funds became the main businesses
of these I-Banks as is evident from the fact that these banks earnings from core
I-Banking activities were accounted for less than 20% while trading in
securities accounts was for 50-70%.

Glass- Steagall Act of 1933 in the US separated investment banks from

commercial banks through section (Section21) of the act which prohibit the
large private banks whose chief business is investment business from
receiving deposits. Prohibition of accepting deposit by these I-Banks works as
deterrent for these I-Banks.

Investment banks like Lehman or Goldman Sachs or Morgan Stanley don’t

have a stable retail deposit base unlike commercial banks where retail deposit
base is very strong by virtue of deposit accepting from their massive retail
customers. Borrowing on short-term basis was financing the purchases of
securities done by I-banks as they lack pools of deposit unlike commercial
banks. There exists problem of constant refinancing of the short-term debt if
these I-Banks are not able to offload security at suitable price in the market
matching the maturity profile of the short-term debt.

This business of borrowing short and getting it refinanced through other short
term source will run along fine as long as the mortgages and other securities
these I-banks hold are stable or are rising in value and thus easy to sell. But
due to the slump in housing market in America these I-banks like Lehman
could not sell the securities they owned. When the market turns nervous,

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T.Y.B.B.I.

creditors stop lending, forcing firms like Lehman to dump holdings at

distressed prices.

But the case with commercial banks is slightly different and a little better in
such raffled conditions. Owing to the long term and perennial deposit base the
commercial banks has the upper hand over I-Banks. The case of distressed
sales of securities will be very minimal with commercial banks but for the I-
Banks it will be wild and rampant leading to erosion of cash, difficulty to run
the businesses and ultimately either bankruptcy or infusion of cash by other
institutions only help. In troubled times commercial banks will not be forced
to sell securities through distress sale rather they hold it till the market are
stabilized but it is the opposite in the case of I-Banks.

Commercial banks accepting deposits are now being hailed as kings in the
financial world as for the failed I-banks, only commercial banks are coming to
their rescue. Hence in case of Bear Sterns it was JP Morgan Bank, for Merrill
Lynch it was Bank of America and another dwindling I-Bank Morgan Stanley
may go into the fold of Wachovia Bank. There are therefore reasons of
anchoring deposit-accepting banks or more commonly called commercial
banks as king of finances.

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T.Y.B.B.I.

Investment Banking: Past, Present, and Future Banking

• Investment banks are changing fast. Forty years ago the industry was
dominated by a few small partnerships that made the bulk of their
income from the commissions they earned floating securities on behalf
of their clients. Today’s investment banks are huge full-service firms
that make a substantial proportion of their revenues in technical trading
businesses that started to attain their current prominence only in the
1980s. The CPI-adjusted capitalization of the top ten investment banks
soared from $1 billion in 1960 to $194 billion in 2000. Between 1979
and 2000, the number of professionals1 employed by the top five
investment banks (ranked by capitalization) rose from 56,000 to
205,000.
• The enormous upheavals documented in the previous paragraphs raise a
number of difficult questions. What have the investment banks of today
got in common with their predecessors? Is it possible to draw any
meaningful parallels between businesses that today call themselves
investment? Banks and the investment banks of 20, 40, or even 100
years ago? What is the source of the recent changes to the investment
banking landscape, and can we say anything about the likely future
direction of the industry?
• These questions point to a more fundamental one: namely, if
investment banks did not exist, would we need to invent them? In other
words, what are investment banks for? A sufficiently general answer to
this question should explain the past evolution of the investment bank,
shed some light upon investment banking policy debates, and help us to
understand the forces currently shaping the investment banking
industry and their likely impact. Surprisingly, although a wealth of
academic and policy work analyzes specific lines of business within
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T.Y.B.B.I.

investment banks, very little has been written to explain the economic
purpose of the investment banking institution. In a recent book we
attempt to fill this gap.
• We argue that investment banks have traditionally added value in
transactions involving assets over which it is extremely hard to
establish property rights. Since their inception, investment banks have
facilitated complex deals by creating a marketplace in which informal
property rights over these assets could be created and enforced. Over
the past 200 years a series of technological advances has altered the
economic situations that require informal property rights, and
investment banks have changed their focus accordingly.
• The immediate antecedents of the modern investment bank
concentrated upon the commodities of the North Atlantic trade; since
the early 19th century, however, the critical asset has been the
information that underpins security market trades. In this article, we
outline our theory and go on to show how it relates to investment
banking history. As we note above and discuss in greater depth below,
large-scale capitalism is underpinned not only by contracts between
capitalists and the businesses and individuals in which they invest, but
also between the sellers and buyers of valuable information.
• Investment banks have always been located at the nexus of these
contracts, and their position has left them particularly exposed to
political interference. We show how the prospect of such interference
relates to our theory, and we point to some relevant 20th-century
examples. Finally, we discuss recent changes to the investment banking
landscape and try to identify some of the trends that will influence the
future development of the industry.

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T.Y.B.B.I.

Investment Banking Analyst Required Skills

Exceptional analytical and quantitative skills and attention to detail

 Excel and PowerPoint will become your best friend
Interpersonal and communication skills

 Demonstrated teamwork and leadership abilities

Proven track record of initiative, achievement and
success
Good academic record and involvement in extracurricular
activities
 Focus on Finance and/or Accounting are assets but
not necessarily required
 Excellent work ethic and time management skills
Solid business acumen
Knowledge of a specific industry is helpful.

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T.Y.B.B.I.

With moderate revenue growth, may not reach 1999 levels until 2005

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T.Y.B.B.I.

Top 10 Investment Banks in India

No Name

1 Avenues Capital

2 Bajaj Capital

3 Cholamandalam Investment & Finance

Company

4 ICICI Securities Ltd

5 IDFC

6 Kotak Mahindra Capital Company

7 SBI Capital Markets

8 Tata Investment Corporation Limited

(TICL)

9 Yes Bank

10 UTI Securities Ltd

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T.Y.B.B.I.

BUSINESS PORTFOLIO OF

INVESTMENT BANKS

Globally, investment banks handle significant fund-based

business of their own in the capital market along with their non-fund
service portfolio which is offered to clients. However, thee distinct
segments are handled either on the same balance sheet or through
subsidiaries and affiliates depending upon the regulatory requirements
in the operating environment of each country. All these activities are
segmented across three broad platforms – equity market activity, debt
market activity and merger and acquisition (M&A) activity. In addition,
given the structure of the market, there is also a segmentation based on
whether a particular investment bank belongs to a banking parent or is a
stand-alone pure investment bank. Following figure represents the broad
spectrum of global investment activity.

From this diagram, it may be appreciated that investment banking

encompasses a wide area of capital market based businesses and
services and has a significant financial exposure to the capital market.
Though investment banks also earn a significant component of their
income from non-fund based activity, it is their capacity to support
clients with fund-based services, which distinguishes them from pure
merchant banks. In the US capital market, investment banks underwrite
issues or buy them outright and sell them later to retail investors thereby
taking upon themselves significant financial exposure to client
companies. Besides, being such large financial power houses
themselves, the global investment banks play a major role as
institutional investors in trading and having large holdings of capital

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T.Y.B.B.I.

market securities. As dealers, they take positions and make a market for
many securities both in the equity and derivative segments. They hold
large inventories and therefore influence the direction of the market.
Goldman Sachs, Salomon Brothers, Merrill Lynch, Schroeders,
Rothschild and others are significant Market Investors both on their own
account and on behalf of the billions of dollars of funds under their
management. The global mergers & acquisitions business is very large
and measures up to trillions of dollars annually. Investment banks play a
lead advisory role in this booming segment of financial advisory
business. Besides, they come in as investors in management buy-outs
and management buy-in transactions. On other occasions, wherein
investments banks manage private equity funds, they also represent their
investors in such buy-out deals.

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T.Y.B.B.I.

I N V E S T M E N T B A N K I N G

C O R E B U S I N E S S P O R T F O L I O

N o n - F u n d b a s e d F u n d b a s e d

E q u it y p o r t f o lio - M e r c h a n t
E q u it y p o r t f o lio - U n d e r w r i t i n g ,
B a n k in g ( I s s u e M a n a g e m e n t ) ,
m a r k e t m a k in g
p r iv a t e p la c e m e n t s .

D e b t p o r t f o lio - I s s u e M a n a g D e em b e t n p t o, r t f o l i o - U n d e r w r i t i n g ,
p r i v a t e p l a c e m e n t , s t r u c t u r me d a rf ki n e a t n m c ea k i n g
is s u a n c e s s u c h a s s e c u r it is a t io n

M & A - M & A a d v is o r y , M & A p o r t f o lio - I n v e s t in g in

c o r p o r a t e a d v i s o r y , p r o j e pc rt i va ad tv e i s e o q r yu i t y , L B O s a n d M B O s

S U P P O R T A C T I V I T Y P O R T F O L

N o n - F u n d b a s e d F u n d b a s e d

E q u i t y p o r t f o lio - E q u it y b r o kE i nq gu , i t y p o r t f o lio - P r o p r ie t a r y t r a d in g
d i s t r ib u t io n , a s s e t m a n a g e am n e d n pt o r t f o lio in v e s t i n g , m a n a g in g
c u s t o d ia l s e r v i c e s , w e a lt h pm r ai v n a a t eg ee mq ue i nt y t f u n d s a n d a s s e t
( p r iv a t e b a n k i n g ) , r e s e a r c hm a a n n d a ga en ma l ye sn i t s f u n d s

D e b t p o r t f o lio - T r a d i n g , u n d e r w r i t in g ,
D e b t p o r t f o lio - D e b t m a r k e t b r o k in g ,
m a r k e t m a k in g a n d in v e s t in g o n o w n
d is t r ib u t io n , a s s e t m a n a g e m e n t ,
a c c o u n t i n d e b t p r o d u c t s a n d
r e s e a r c h
s e c u r i t is e d in s t r u m e n t s

D e r iv a t iv e p o r t f o l i o - D e r i v a Dt i ve er i v a t i v e p o r t f o l io - P r o p r ie t a r y
b r o k i n g , r i s k m a n a g e m e n t t, r ac ud si n t og d, ima l a n a g i n g h e d g e f u n d s .
s e r v ic e s .

Page | 46
T.Y.B.B.I.

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T.Y.B.B.I.

SERVICE PORTFOLIO OF INDIAN

INVESTMENT BANKS

The core services provided by Indian investment banks are in the

areas of equity market, debt market and advisory services. These are
profiled below:

Core Services
 Merchant Banking, Underwriting and Book Running
The primary market which was quite small in India, was
revitalized with the abolition of the Capital Issues (Control) Act, 1947
and the passing of the Securities and Exchange Board of India Act,
1992. the SEBI functions as the regulator for the capital markets similar
to its counterpart, the SEC in USA. SEBI vide its guidelines dated June
aa, 1992 introduced free pricing of securities in public offers for the first
time in India. Over the last ten years, there have been two distinct
phases of primary market boom – the first between 1992-1996 and the
second between 1998-2001. The third wave of primary market issues
could shape up in the near future. This market is very closely regulated
by SEBI. In the days when the public offers market is very vibrant, this
area of service forms the main activity for most Indian investment
banks. In the past few years, though public offers have been very few,
he private placement market, especially in the debt segment has been
very active and has served as an important source of funds for prime-
rated corporate. Notable among such offerings are rated privately placed
debentures issued by public sector corporations and leading private
companies. Financial institutions have been raising funds via the public
offer of unsecured bonds. Investment banks have been managing the

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T.Y.B.B.I.

public offers and hand holding them in private placements as well. Once
the private placement markets also come under regulatory stipulations,
investment banks have a wider role to play in such issuances.

 Mergers and Acquisitions Advisory

The mergers and acquisitions industry was pretty nascent in India
prior to 1994 and continues to be tiny compared to the global scale of
such transactions. However, two main factors that have given a big push
to this industry are:
 The factors of liberalization and globalization that have
forced the Indian industry to consolidate.
 The institutionalization of corporate acquisitions by SEBI
through its guidelines, popularly known as the Takeover
Code.

One of the cream activities of investment banks has always been

M&A advisory. The larger investment banks specialize in M&A as a
core activity. While some of them provide pure advisory services in
relation to M&A, others holding valid merchant banking licences from
SEBI also manage the open offers arising out of such corporate events.

 Corporate Advisory
Investment banks in India also have a large practice in corporate
advisory services relating to project financing, corporate financing,
capital restructuring though equity repurchases (including management
of buyback offers under section 77A of the Companies Act, 1956),
raising private equity, structuring joint ventures and strategic
partnerships and other such value added specialized areas.

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T.Y.B.B.I.

Support Services and Businesses

 Secondary Market Activities
Most of the universal banks such as ICICI, IDBI and Kotak
Mahindra have their broking and distribution firms in both the equity
and debt segments of the secondary market. In addition several other
investment banks such as the IL & FS and pure investment banks such
as DSP Merrill Lynch and JM Morgan Stanley have a strong presence in
this area of activity. In the past few years, the derivative segment has
been introduced in Indian Capital market and this provides an additional
avenue of specialization for investment banks. Derivative Trading, risk
management and structured product offerings are the new segments that
are fast becoming the areas of future potential for Indian investment
banks. The securities business also provides extensive research
offerings and guidance to investors. The secondary market services
cater to both the institutional and non-institutional investors.

 Asset Management Services

Most of the top financial groups in India which have investment
banking businesses such as the – ICICI, the IDBI, Kotak Mahindra,
DSP Merrill Lynch, JM Morgan Stanley, SBI and IL&FS also have
their presence in the asset management business through separate
entities. As per the three layer structure propounded by SEBI, the parent
organization acts as the sponsor of the fund and the fund itself is
constituted as a trust. The trust is managed by an asset management
company and a separate trustee company which oversees the interests of
the unit holders in the Mutual Fund. The whole structure has an arm’s
length distance from the sponsor’s other business and entities.

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T.Y.B.B.I.

 Wealth Management Services (Private Banking)

Many reputed investment banks nurture a separate service
segment to manage the portfolio of high net worth individuals,
households, trusts and other type of non-institutional investors. This can
be structured either as a pure advisory service wherein the investment
manager does not have any access to the funds or as a fund management
service wherein the investment manager is given charge of the funds. In
the former case, it becomes a non-discretionary portfolio and in the
latter case, it becomes a discretionary portfolio. Such activity is
regulated under the SEBI guidelines. In other cases, wealth management
may be restricted based activity wherein the investor is provided good
investment recommendations from time to time.

 Institutional Investing
Institutional investors have been a recent phenomenon in the
Indian capital market, which till then had the presence of a handful of
public financial institutions such as the UTI and the insurance
companies. The term lending institutions such as the IDBI and IFCI did
not participate in secondary market dealing as a matter of policy. With
the advent of liberalization, there are presently a large number of
domestic institutional investors in the secondary market apart from
approved foreign institutional investors. In addition, institutional
investments have risen significantly in the primary markets through
venture capital and private equity investments by investors in both the
domestic and non-resident categories. Several of the leading investment
banks either have dedicated venture funds or private equity funds that
invest in primary market. In addition, they make proprietary
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T.Y.B.B.I.

investments in the secondary market through their dealing and market

making activities. The business portfolio of Indian Investment banks has
been briefly explained in following figure.

UBS
Citigroup CSFB Deutsche J. P. Morgan
Warburg
(US) (Swiss) (German) (US)
(Swiss)
Deutsche J.P. Morgan UBS
Citibank CSFB
Bank Chase Warburg
Salmon Smith
Donaldson, Chemical
Barney Morgan
Lufkin & Bank Dillion Read
(Investment Grenfell
Jenrette (merged)
Bank)
Beacon
Schroders Pershing Alex Brown Paine Webber
Group

Robert Philips &

Bankers Trust
Fleming Drew

Hambrecht & Swiss Bank

Quist (merged)
Universal Banks and their investment banking affiliates

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T.Y.B.B.I.

INVESTMENT BANKING AND MERCHANT

BANKING DISTINGUISHED

Merchant banks and investment banks, in their purest forms, are

different kinds of financial institutions that perform different services.
In practice, the fine lines that separate the functions of merchant banks
and investment banks tend to blur. Traditional merchant banks often
expand into the field of securities underwriting, while many investment
banks participate in trade financing activities. In theory, investment
banks and merchant banks perform different functions.

Merchant Banking as term suggests, is the function of

intermediation in the capital market. It consists of assisting issuers to
raise capital by placement of securities issued by them with investors.
However, merchant banking is not merely about marketing of securities
in an agency capacity. The Merchant Banker has an onerous
responsibility towards the investors who invest in such securities. The
regulatory authorities require the merchant banking firms to promote
quality issues, maintain integrity and ensure compliance with the law on
own account and on behalf of the issuers as well. Therefore, merchant
banking is a fee based service for management of public offers,
popularly known as ‘issue management’ and for private placement of
securities in the capital market. In India, the Merchant Banker leading a
public offer is also called as the ‘Lead Manager’.

On the other hand, the term ‘Investment banking’ has a much

wider connotation and is gradually becoming more of an inclusive term
to refer to all types of capital market activity, both fund-based and non-

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fund based. This development has been driven more by the way the
American investment banks have evolved themselves over the past
century. Given the situation, investment banking encompasses not
merely merchant banking but other related capital market activities such
as -- stock trading, market making, underwriting, broking and asset
management as well. Besides the above, investment banks also provide
a host of specialized corporate advisory services in the areas of project
advisory, business and financial advisory and mergers and acquisitions
Pure investment banks raise funds for businesses and some
governments by registering and issuing debt or equity and selling it on a
market. Traditionally, investment banks only participated in underwriting and
selling securities in large blocks. Investment banks facilitate mergers and
acquisitions through share sales and provide research and financial consulting
to companies. Traditionally, investment banks did not deal with the general
public.

Traditional merchant banks primarily perform international

financing activities such as foreign corporate investing, foreign real
estate investment, trade finance and international transaction
facilitation. Some of the activities that a pure merchant bank is involved
in may include issuing letters of credit, transferring funds
internationally, trade consulting and co-investment in projects involving
trade of one form or another.
The current offering of investment banks and merchant banks
varies by the institution offering the services, but there are a
few characteristics that most companies that offer both investment and
merchant banking share.

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As a general rule, investment banks focus on initial public

offerings (IPOs) and large public and private share offerings. Merchant
banks tend to operate on small-scale companies and offer creative
equity financing, bridge financing, mezzanine financing and a number
of corporate credit products. While investment banks tend to focus on
larger companies, merchant banks offer their services to companies that
are too big for venture capital firms to serve properly, but are still too
small to make a compelling public share offering on a large exchange.
In order to bridge the gap between venture capital and a public
offering, larger merchant banks tend to privately place equity with other
financial institutions, often taking on large portions of ownership in
companies that are believed to have strong growth potential.

Merchant banks still offer trade financing products to their

clients. Investment banks rarely offer trade financing because most
investment banking clients have already outgrown the need for trade
financing and the various credit products linked to it.

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T.Y.B.B.I.

REGULATORY FRAMEWORK FOR INVESTMENT

BANKING

Investment banking in India is regulated in its various facets

under separate legislations or guidelines issued under statute. The
regulatory powers are also distributed between different regulators
depending upon the constitution and status of investment bank. Pure
investment banks which do not have presence in the lending or banking
business are governed primarily by the capital market regulator (SEBI).
However, universal banks and NBFC investment banks are regulated
primarily by the RBI in their core business of banking or lending and so
far as the investment banking segment is concerned, they are also
regulated by SEBI. An overview of the regulatory framework is
furnished below:
 At the constitutional level, all investment banking companies
incorporated under the Companies Act, 1956 was governed by the
provisions of that Act.
 Investment banks that are incorporated under a separate statute such
as the SBI or IDBI are regulated by their respective statute. IDBI is
in the process of being converted into a company under the
Companies Act.
 Universal Banks are regulated by the Reserve Bank of India under
the RBI Act, 1934 and the Banking Regulation Act which put
restrictions on the investment banking exposures to be taken by
banks. The RBI has relaxed the exposure limits for merchant
banking subsidiaries of commercial banks. Till now, such companies
were restricting their exposure to a single entity through the
underwriting business and other fund based commitments such as

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standby facilities etc. to 25% of their net owned funds (NOF).

Therefore these companies are now on par with other investment
banks which can do so upto 20 times their NOF.
 Investment banking companies that are constituted as non-banking
financial companies are regulated operationally by the RBI under
Chapter IIIB (sections 45H to 45QB) of the Reserve Bank of India
Act, 1934. Uunder these sections RBI I empowered to issue
directions in the area of resource mobilization, accounts and
administrative controls. The following directions have been issued
by the RBI so far:
• Non-Banking Financial Companies Acceptance of Deposits
(Reserve Bank) Directions, 1998.
• NBFCs Prudential Norms (Reserve Bank) Directions, 1998.
 Functional, different aspects of investment banking are regulated
under the Securities and Exchange Board of India Act, 1992 and
the guidelines and regulations issued there under. These are listed
below:
• Merchant banking business consisting of management of public
offers is a licenced and regulated activity under the Securities and
Exchange Board of India (Merchant Bankers) Rules 1992 and
Securities and Exchange Board of India (Merchant Bankers)
Regulations 1992.
• Underwriting business is regulated under the SEBI
(Underwriters) Rules, 1993 and the SEBI (Underwriters)
Regulations 1993.
• The activity of secondary market operations including stock
broking are regulated under the relevant by-laws of the stock
exchange and the SEBI (Stock Brokers and Sub Brokers) Rules

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T.Y.B.B.I.

1992 and the (Stock Brokers and Sub Brokers) Regulations 1992.
Besides, for curbing unethical trading practices, SEBI has
promulgated the SEBI (Prohibition of Insider Trading)
Regulations, 1992 and the SEBI (Prohibition of Fraudulent and
Unfair Trade Practices Relating to Securities Markets)
Regulations 1995.
• The business of asset management as mutual funds is regulated
under the SEBI (Mutual Funds) Regulations 1996.
• The business of portfolio management is regulated under the
SEBI (Portfolio Managers) Rules, 1993 and the SEBI (Portfolio
Managers) Regulations, 1993.
• The business of venture capital and private equity by such funds
that are incorporated in India is regulated by the SEBI (Venture
Capital Funds) Regulations, 1996 and by those that are
incorporated outside India s regulated under the SEBI (Foreign
Venture Capital Funds) Regulations 2000.
• The business of institutional investing by foreign investment
banks and other investors in India secondary markets is governed
by the SEBI (Foreign Institutional Investors) Regulations 1995.
 Investment banks that are set up in India with foreign direct
investment either as joint ventures with Indian partners or as fully
owned subsidiaries of the foreign entities are governed in respect
of the foreign investment by the Foreign Exchange Management
Act, 1999 and the Foreign Exchange Management (Transfer of
issue of security by a Person Resident outside India) Regulations
2000 issued there under as amended from time to time through
circulars issued by the RBI.

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 Apart from the above specific regulations relating to investment

banking, investment banks are also governed by other laws
applicable to all other businesses such as the-tax law, property
law, local state laws, arbitration law and the other general laws
that are applicable in India.

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T.Y.B.B.I.

ROLE OF INVESTMENT BANKER

In case of Listed Companies

Listed companies have several areas where investment bankers
play a significant role as advisors and issue managers. In some of these
areas, apart from playing the statutory role of merchant bankers, they
also take significant financial exposure in underwriting, providing
safety nets, market making and in placement obligations to issuer
companies. There are other areas as well, wherein the investment
bankers’ guide listed companies. The functional areas for investment
bankers in listed companies are thus listed below:
 Acting as advisers and arrangers in raising debt and equity finance
through the capital market.
 Acting as advisors and arrangers for private placement of debt and
equity.
 Acting as merchant bankers for transactions relating to secondary public
offers, right issues and composite issues.
 Advise companies on pricing and valuation for various types of offers.
 Advise companies on post-listing issues and offerings.
 Advise promoters and help in transactions relating to creeping
acquisitions, dilution management, open offers and preferential
allotments.
 Advise companies on delisting and act as merchant bankers for delisting
offers.
 Advise companies on buy backs and act as merchant bankers for such
offers.
 Advise companies on market capitalization and related issues.

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T.Y.B.B.I.

 Advise companies on issue of sweat equity, shares with differential

rights, ESOPs and ESPS.
 Act as sponsor / merchant bankers for private equity deals / bought out
deals with subsequent offers for sale.

The above list is not intended to be exhaustive. However, it

brings out the fact that the service areas are many insofar as listed
companies are concerned. Full service investment banks come in with
other strengths as well, such as in mergers and acquisitions, project
finance, restructuring and other corporate advisory services.

 Due diligence
Armed with information about the company and its operations,
the short listed candidates are then allowed to visit the Data Room
prepared for the purpose of due diligence. An advisor has a critical role
to play in the performance of due diligence. It is at this stage that the
bidding company gets an opportunity to see the various documents and
books of the company being disinvested and also visit the
manufacturing facilities of the company. Information that is gathered at
this stage is critical in the preparation of the bid document. Since due
diligence has to be performed within the given time, sufficient
preparation and care has to be taken to ensure that all information that is
required is obtained and that there are no information gaps or lack of
understanding on any issue subsisting thereafter. Among the documents,
special mention has to be made about the draft SPA and the SHA that
would be provided to the bidders at this stage. These are two important
documents that need to be examined in detail. Legal advise is normally
sought for this purpose. Special attention has to be paid to important

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clauses that deal with employees, affirmative rights of the Government

on certain issues, exit mechanism, board representation and indemnity.
Since these documents become the center point for all future
negotiations, it is upmost importance that these are examined and
understood well before submitting the final bids.

 Valuation and Preparation of the Final Bid

The last stage in the bidding process would be to actually prepare
the final bid document. As bids are normally required to be submitted in
two parts i.e. the financial bid and the technical bid. The bid documents
have to be filled in without any errors or misrepresentation. The
financial bid is the price that the company / group / consortium are
willing to pay to acquire a strategic stake in the company being
disinvested. Hence to arrive at this price, a detailed valuation has to be
made by the advisor based on the information furnished in the CIM and
discussions with the global advisors to the Government or the officials
of the PSU. The advisor has to use all the skills and prior experience
required for this purpose, along with a lot of market intelligence in
arriving at the appropriate financial bid. The recommendations on the
valuations have to be discussed with the management to arrive at the
final price. The technical bid would normally contain information about
the bidder’s track record, financial performance, reasons for bidding,
detailed plan of action for the company being acquired and required
documentary evidence.

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Usual documents that are required are:

 Bank Guarantee
 Board Authorization
 Application under Section 108A of the Companies Act, if
required
 FIPB / SIA application, if required
 Copy of the Share holders’ agreement / Share Purchase
agreement authenticated by the bidder based on which the
bid has been made.
 Other documents if any.

Bidders are allowed to be present at the time of opening the bids.

Thereafter, the highest bidder is called for negotiation and conclusion of
the deal. The advisor plays a very important role at this stage and has to
demonstrate the necessary skills in concluding the transaction in the best
interest of the client.

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T.Y.B.B.I.

FINANCIAL RESTRUCTURING ADVISORY

In the life of a body corporate, there are times when a

physiological restructuring becomes necessary. This could be caused by
business reasons or financial factors.

‘Financial Restructuring’ as the term denotes is the art of restating

the financial position of a company as reflected by its balance sheet as
on a given date. In order to achieve such restatement, a complex
financial and legal process is involved as it concerns several conflicting
interests. Financial restructuring can be triggered off either from the
asset side of the balance sheet or the liabilities side. If the asset side is to
be restated, it involves revaluation of assets, so as to arrive at their true
values, and restate the asset side accordingly. Once the asset side is
restated, the corresponding adjustment is made on the liabilities’ side to
arrive at the restated balance sheet. Such adjustment would depend upon
whether there is a net increase or decrease in the value of the assets
upon revaluation. If the net total on the asset side is an increase, it
results in an increase in the ‘reserves’ so as to equate the liabilities’ side
and vice-versa.

Financial restructuring is triggered off from the liabilities’ side as

well. This happens due to change in the status of the outside liabilities
of a company either due to negotiations or statutory provisions or any
other reason. In contrast, a change in the values of the shareholders’
funds is necessitated normally due to change in the values of assets as
discussed above. Therefore financial restructuring encompasses
restructuring of debt capital (outside liabilities) as well as equity capital.

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T.Y.B.B.I.

NEED & REQUIREMENTS OF INVESTMENT BANK

Who Need An Investment Bank?

Any firm contemplating a significant transaction can benefit from
the advice of an investment bank. Although large corporations often
have sophisticated finance and corporate development departments, an
investment bank provides objectivity, a valuable contact network,
allows for efficient use of client personnel, and is vitally interested in
seeing the transaction close.

Most small to medium sized companies do not have a large in-

house staff, and in a financial transaction may be at a disadvantage
versus larger competitors. A quality investment banking firm can
provide the services required to initiate and execute a major transaction,
thereby empowering small to medium sized companies with financial
and transaction experience without the addition of permanent overhead.

Need & Requirements

Investment banking is a service business, and the client should
expect top-notch service from the investment banking firm. Generally
only large client firms will get this type of service from the major Wall
Street investment banks; companies with less than about $100 million in
revenues are better served by smaller investment banks. Some criteria to
consider include:

 Services Offered
For all functions except sales and trading, the services should go
well beyond simply making introductions, or "brokering" a transaction.
For example, most projects will include detailed industry and financial
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analysis, preparation of relevant documentation such as an offering

memorandum or presentation to the Board of Directors, assistance with
due diligence, negotiating the terms of the transaction, coordinating
legal, accounting, and other advisors, and generally assisting in all
phases of the project to ensure successful completion.

 Experience
It extremely important to make sure that experienced, senior
members of the investment banking firm will be active in the project on
a day-to-day basis. Depending on the type of transaction, it may be
preferable to work with an investment bank that has some background
in your specific industry segment. The investment bank should have a
wide network of relevant contacts, such as potential investors or
companies that could be approached for acquisition.

 Record of Success
Although no reputable investment bank will guarantee success,
the firm must have a demonstrated record of closing transactions.

 Ability to Work Quickly

Often, investment banking projects have very specific deadlines,
for example when bidding on a company that is for sale. The investment
bank must be willing and able to put the right people on the project and
work diligently to meet critical deadlines.

 Fee Structure
Generally, an investment bank will charge an initial retainer fee,
which may be one-time or monthly, with the majority of the fee
contingent upon successful completion of the transaction. It is important

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T.Y.B.B.I.

to utilize a fee structure that aligns the investment bank's incentive with
your own.

 Ongoing Support
Having worked on a transaction for your company, the
investment bank will be intimately familiar with your business. After
the transaction, a good investment bank should become a trusted
business advisor that can be called upon informally for advice and
support on an ongoing basis.

Because investment banks are intermediaries, and generally not

providers of capital, some executives elect to execute transactions
without an investment bank in order to avoid the fees. However, an
experienced, quality investment bank adds significant cant value to a
transaction and can pay for its fee many times over.

The investment banker has a vested interest in making sure the

transaction closes, that the project is completed in an efficient time
frame, and with terms that provide maximum value to the client. At the
same time, the client is able to focus on running the business, rather
than on the day-to-day details of the transaction, knowing that the
transaction is being handled by individuals with experience in executing
similar projects.

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T.Y.B.B.I.

RECENT TRENDS IN INVESTMENT BANKING

One of the trends that have been developing in the past few years
in the global and Indian investment banking arena, is the strong
emergence of universal banks ahead of pure investment banks as market
leaders. These universal banks have the additional financial muscle of
their banking arms that add to their investment banking strengths. Pure
investment banks have found it unmanageable to maintain leadership
positions due to difficult market conditions and the economic downturn.
The year 2002 has been dubbed as the watershed year in investment
banking for over a decade. Globally, universal banks such as the –
Citigroup, JP Morgan Chase and Deutsche Bank are emerging strongly
against pure investment banks such as Goldman Sachs and Morgan
Stanley. This trend could probably reappear in India as well with the
emergence of SBI, ICICI, IDBI and Kotak Mahindra Bank as strong
universal banks. However, in 2002, pure investment banks such as JM
Morgan Stanley and DSP Merrill Lynch still occupied top positions in
the investment banking league tables.

Some recent developments in the investment banking industry as

reported in some financial dailies and other press clippings are listed
below:

International
 The Wall Street IPO market has been the fewest number of issues since
1978 in the calendar year 2003, with just five in the first quarter. These
have mostly been from insurance and financial services firms and four
of them were IPOs.

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 In 2002, there was a drop of 28% in global equity related issuances

according to Thomson Financial. IPOs were the main casualty with a
drop of 34% to $60.6 billion. European markets saw a 53% drop in
IPOs and 54% drop in convertible bond issuances. In Europe, the
market focus has shifted from fund raising through IPOs and public
issues to more of restructuring deals. These are termed as ‘rescue
finance’ deals such as rights issues and fully convertible bond issues by
troubled companies. Ericsson, Sonera and Zurich Financial Services are
some companies that made rights issues in 2002. According to
Dealogic, the volume of rights issues in Europe rose from $20.7 billion
to $21.5 billion in 2002. The most popular instrument in USA and
Europe has been the ‘mandatory convertible’ (fully convertible) bond
which is considered as forward share sales which is superior in nature to
a right issue.
 The Citigroup was Wall Street’s top stock and bond underwriter in
2002. Citigroup affiliate Salomon Smith Barney arranged $414 billion
of offerings with a 10.6% market share according to Thomson
Financial. Merrill Lynch and CSFB were ranked second and third
respectively. However, the total underwriting pie fell by 5% during the
same year.
 The top IPO investment bank in 2002 was Salomon Smith Barney
followed by Goldman Sachs. Goldman arranged the largest IPO of
2002, the $4.6 billiom CIT Group Inc. (Tyco International Ltd.) unit.
 The reported fee of American investment banks fell by 21% in 2002 to
$14.1 billion. Salomon took the highest fee of around $2 billion
followed by the other two with around $1.2 billion each. Since April
2001, 78000 jobs were slashed in this industry in USA accounting for
about 10% of the total strength.

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T.Y.B.B.I.

 Global M&A market was also dull in 2002 witnessing a sharp fall of
47% to stand at $996 billion from $1,887 billion in the previous year.
The biggest deals in 2002 were HP-Compaq, Amgen-Immunex Corp,
AOL Time Warner – AOL Europe, Bayer – Aventis Crop Science,
Comcast Corp, AT & T Broadband, Philips Petroleum – Conoco, and
Siemens Robert Bosch Atccs Mannesmann.
 Some of the big universal banks such as JP Morgan Chase took major
hits in their private equity businesses due to the technology meltdown.
Incidentally, JP Morgan, which is one of Wall Street’s largest private
equity operators with a fund base of $28 billion, generated $130 million
in revenues in private equity in 2001 fuelled mainly by the IPO market
boom in technology stocks. Due to the meltdown, many investment
banks have felt it necessary to spin off their private equity operations
into separate entities. BNP Paribas, Deutsche Bank, HSBC and Zurich
Financial Services are some of those banks.

National
 During the year 2001, JM Morgan Stanley which acted as advisor to
M&A deals worth Rs. 16,022 crore was rated the top investment bank in
India. the other players in the big league were – ABN Amro (Rs.10,460
crore), DSP Merrill Lynch (Rs.7130 crore), Arthur Andersen (now part
of E7Y, Rs.3532 crore), Kotak Mahindra (Rs.1719 crore), Rabo India
Finance (Rs.833 crore) and Lazard Capital (Rs.536 crore) – (as reported
in The Economic Times 21st November, 2001).
 In 2002, there was only one GDR/ADR issue as compared to 6 in 2001
and 9 in 2000. this was made by Mascon Global which raised $10
million through issue of 2.5 million GDRs which are listed at
Luxembourg Stock Exchange. In this market, Citibank was the leading

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T.Y.B.B.I.

depository bank according to Instanex Capital Consultants. This was

followed by Bank of New York, Deutsche Bank and JP Morgan.
 In the M&A market, the year 2002 saw an increase of around 5% in the
value of M&A deals in India. Among these, more than 50% were cross-
border deals according to a survey conducted by KPMG Corporate
finance. The deals were mostly in the SME segment with average size
not exceeding $25 million. The banking, finance and insurance sectors
contributed almost one third of the total volume. Privatization deals also
played a significant part.
 DSP-ML de-listed from the stock exchanges since its promoters,
Hemendra Kothari and Merrill Lynch together held more than 90% of
the shares. DSP was rated ‘The Best Domestic Investment Bank’ in
India for 2000 by Finance Asia. Euromoney voted it ‘Best Domestic
M&A House in India’ as well as ‘Best Domestic Equity House in India’
in 2000. Tthis distinction has returned for three years in a row with
DSP-Ml being named as the ‘Best Domestic Securities House’ and
‘Best Domestic Investment Bank’ for 2002-2003 by Asiamoney (May
2003 issue) and The Asset (January 2003 issue) magazine respectively.

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T.Y.B.B.I.

CONCLUSION

Looking to the scope for investment banking in India, the future

looks bright for the industry as a whole in India. This will lead India’s
development in the world; also it will increase the wealth of the country.

Many more pure merchant banks and advisory firms could

convert themselves into full service investment banks that would
broaden the market and make the service delivery much more efficient.
In addition, the technological and market developments shaping the
capital market would also provide an added impetus to the growth of
investment banking. Better regulatory supervision and stricter
enforcement of the code of conduct of market intermediaries would
ensure that better quality issuers come to the market and existing issuers
would also enhanced standards of corporate governance.

In the long run, all these developments would ensure fair return to
investors, and bring back investor support to the market. This would
augur well for the capital market in general and investment banking
particular. Thus, development of investment bank will build Investment
Market in the country.

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T.Y.B.B.I.

BIBLIOGRAPHY

BOOKS

 Investment Banking Handbook by J. Peter Williamson.

 Investment Banking Theory & Pratice by Edward Gardener & Philip
Molyeux.
 Investment Banking in the Financial System by Charles R. Geisst,
Prentice – Hall.
 Investment Banking by Pratap G. Subramanyam
 Investment Banking and Brokerage by John F. Marshall and
M.E.Mills, Probus Publishing.
 Indian Financial System by H. R. Machiraju, Vikas Publishing
House Pvt. Ltd., Reprint 2000.

NEWS PAPER ARTICLES

 The Economic Times
 Business Standard

WEBSITES

 http://www.projectsparadise.com/investment-banking-project

 http://www.scribd.com/doc/19288365/investment-banking

 http://www.wisegeek.com/what-is-the-investment-banking.html

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