The Pros and Cons of Investment Banking

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Introduction

Investment banking is an area of banking that assists various firms to acquire capital. Investment banking also provides companies with advices regarding various transactions. In the banking sector, various companies have a preference of investing in either commercial banking or investment banking. Although it was illegal for a single financial institution to own both investment and commercial banking in the US, the Gramm-Laech-Bliley Act allowed a single company to operate the two banking sections at the same time. This act was initiated in the financial sector in the year 1999. Many institutions have seen the importance of investment banks, given that many firms are able to raise capital by underwriting securities. The investment banks also act as agents of clients during the issuance of market securities. For amalgamated corporations and firms that are implicated in acquisitions, investment banks assist them in buying and selling a variety of stocks such as rigid income stocks, equities, derivatives and overseas exchange. The major discrepancy between investment bank and moneymaking banks is that an investment bank would never allow deposits. In 1999, the US financial regulations demanded the separation of investment banking from commercial banking. Other G8 countries have not yet appreciated the difference existing between the two sections of the banking sector.

Some analysts recognize that investment banking can be categorized into two types. This involves both the buy side and the sell side (Klyuev 68). The sell side is concerned with trading of marketable securities for either marketable instruments or cash. The sell side further manages advertisements of services in the market through research and countersigning stocks. The acquisition side is concerned with a variety of finances such as the hedge finances, retirement funds and reciprocated finances. The sell side is also concerned with investment in the public. All investment banks are said to have both the sell side and the buy side elements. The investment banking may as well be classified into two business sections that is, private and public sections. The insider information, which cannot be disclosed to the public, is said to be on the side of private function. In the US, the Financial Industry Regulatory Authority and the Securities & Exchange Commission regulate the investment banking sector.

Importance of Investment bankers in the banking industry

Investment banks play important roles in the economy. This implies that they cannot be ignored in any way. Their core functions have enabled the banking industry to gain popularity given that both individuals and corporations gain from financial institutions in terms of advice and profits. The core functions of these banks are as mentioned below.

Raising capital

Investment bankers have for long helped their clients to raise funds for various projects in the capital market. These financial institutions also offer advice to clients regarding both acquisitions and mergers. Analysts claim that many investment banks raise substantial profits through merging consultancy services.

Brokerage services

Brokerage services refer to activities related to trading, as well as execution of various business deals on behalf of clients. The brokerage activities are said to provide the market with liquidity cash. A number of investment bankers provide brokerage services relating to buying and selling of various marketable securities, such as debt instruments, equities and mutual funds. The purchase of marketable instruments ensures that the financial market is provided with adequate information that can be utilized in carrying out other pertinent transactions. Therefore, investment bankers play an important role in providing liquidity cash to the market.

Proprietary trading

The investment banks are also referred to as proprietors since they are involved in trading of marketable instruments using their own money as opposed to that of investors. Their activities, such as those relating to raising capital for various companies by selling debt instruments and equities through the capital market, make these financial institutions strong in the banking industry. Other financial institutions in the banking industry such as commercial banks and retail banks have always been disinterested in raising capital for investors.

Research activities

Research activities are concerned with reviewing the performance of companies, as well as forecasting future performances. Their performances are normally based on buy and sell ratings. A good number of financial analysts argue that, although research could be associated with giving advice to investors, research regarding market performance has been performed by investment banks over years.

Sales and trading

It is the most cost-effective role of many investment banks because it donates a considerable profit. Other divisions of the investment banks contribute small amounts of revenues. During the marketing process, investment banks normally target the purchase of marketable instruments, such as corporate bonds and stocks. They usually aim at making significant profits. The sales division is responsible for finding both individual and institutional investors to purchase bonds and equities that are underwritten by the investment bank. The sales division is also responsible for searching various investors that are willing to sell marketable securities, such as commodities and stocks.

Disadvantages of Investment Banks

Although investment banks play important roles in the economy, they are also associated with various problems, which make them less important in the economy. Before the year 1999, the US and other economies in the world did not appreciate that the banking sector needed to be divided into various sectors to enable easy regulation of the financial market.

Possibility of market manipulation

Regulations and laws governing investment banks such as those provided by FSA and SEC may require investment banks to put in place firewalls that would help to prevent communication regarding decision making. In the 2001 stock market crisis, a number of concerns regarding malpractices in the investment banks were raised. Analysts argued that in 1990s, equity analysts in a number of investment banks bought and sold equities that had encouraging ratings. On the other hand, other business institutions would try to avert investment-banking unless their shares are rated positively. The equity analysts are supposed to instigate insurance services for firms, with an intention of forming links that would lead to beneficial investments in the banking industry. The investment banks are also accused of selling marketable securities that do not match the acknowledged risk profiles of consumers. This could result to sell of extra stocks in the market during public offering. Retail brokerages owned by investment banks carried out these activities in 1990s. Due to this, the public would perceive the stocks in the market as favourable (Aaker 12). Front running is unlawful since a dealer undertakes orders for own account before executing orders earlier submitted by clients. This behaviour of trading may encourage investment banks to take advantage of adjustments in prices regarding the orders. This may lead to unfair practices among investors. Unfair practices tend to destabilize the market since some investors fear venturing in risky operations. It is therefore the role of state authorities to ensure that fair practices are exercised in the investment industry. However, the government should not put too much pressure on investment banks.

Low returns

Most investment banks in the contemporary world pay institutional and individual investors low returns. The checking accounts have been said to earn investors no returns. On the other hand, the savings accounts earn investors small returns ranging from 1% to 2%. Analysts in the financial sector argue that, with huge investments in the investment bank, one is destined to earn paltry returns. Analysts also argue that accounts and Certificate of Deposits pay considerably high returns when compared to those of investment banks. The normal rates earned by the money market CDs and accounts is 5%.

Conclusion

Given that investment banking is concerned with raising capital for firms through capital markets, one would notice that investment bankers are critical to various businesses that would wish to raise external capital. The external capital is normally raised through public floatation and placement of private securities. For firms that are initiating IPOs, functions of investment banks become crucial. A number of analysts argue that the effectiveness of investment banks as regards to IPOs have offered a competitive advantage to many firms. Various companies rely on investment banks for effective pricing of services, provision of auxiliary services and investment banking experience. However, these financial institutions are accused of failing to impose a firewall that would help prevent communication between decision-makers on one side and stock trading and research on the other side.

Works Cited

Aaker, David. Marketing Research. New York, NY: John Wiley and Sons, 2001. Print.

Currie, David. Country Analysis: Understanding Economic and Political Performance. New York, NY: Gower Publishing Limited, 2011. Print.

Klyuev, Vladimir. Access to Finance for Small Borrowers in Canada. York: York University Press, 2008. Print.

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