What is investment banking, and why is it so important for companies?

Investment banking helps many organizations obtain financing and offers advice on all kinds of transactions

In everyday life, there is a set of indispensables. Products that virtually the entire population owns, and without them communicating, getting around or acquiring goods would be challenging. Who doesn't have a cell phone? Or a means of transport, be it a car or a bicycle? Or a bank account?

When talking about banks, it is common for people to think of the branch where they go to deposit or withdraw money. However, there is another type of bank whose clients are not ordinary citizens but companies or large fortunes. We are talking about investment banking.

The main objective of investment banking is to help these people, both individuals and legal entities, to obtain financing and increase their capital. To achieve this, they issue and sell securities in the financial markets and design IPO strategies intending to attract the maximum number of funds. In addition, they often act as intermediaries in merger or acquisition processes, providing advisory and consultancy services.

These entities became famous almost a century ago in the United States due to the 1929 crash. After the impact of the crisis, it was decided that it was preferable not to mix citizens' savings with money intended for investment to provide more guarantees to individuals in the event of another financial meltdown. This is how the Glass-Steagall or Banking Act, included in the New Deal program promoted by Franklin D. Roosevelt, came into force.

Although it was repealed a few decades later, this separation from retail banking marked the definitive birth of investment banking. It paved the way for the emergence of today's world-renowned giants, such as JP Morgan Chase, Goldman Sachs, and Morgan Stanley.

What is investment banking?

As we have just seen, although it is instinctively thought that the primary mission of banks is to store the money of millions of individuals and grant loans, not all institutions are like that. And in investment banking, as the name suggests, investment is one of the essential pillars.

In this case, the aim is to increase the wealth of the organizations that place their trust in them. For this reason, its employees must be extremely skilled and qualified professionals since they must carry out highly complex operations and manage substantial amounts of money.

In investment banking, different activities are carried out, including the following:

• Management of IPOs: Investment banking employees coordinate and advise companies during IPO processes, as well as in other operations aimed at increasing their capital. It is also common for them to provide support when placing their shares on the market, offering them to other clients or retail banking users.
• Guidance during mergers and acquisitions: Investment banking provides comprehensive advice on M&A (mergers and acquisitions), including the search for interested companies, negotiation mediation, risk assessment, and review of all legal aspects.
• Direct debit: Investment banking employees also manage direct debits, which function similarly to a wire transfer. The difference is that, in this case, the payment is ordered by the beneficiary and not by the payer, who merely accepts the transaction, thus speeding up management and shortening times.
• Other financing services: To help your customers obtain the financing they need, you can resort to loans, credits, alternative mechanisms (such as factoring or confirming), or leasing (the leasing of a particular asset, leaving the door open to a possible purchase).
• Issuance of other financial products: It can also advise and collaborate in the distribution of debt or structured products (those that combine two or more products into one) to provide companies with the liquidity they need.

Types of investment banking

Just as there is no single type of banking, there is no single type of investment banking. To begin with, it is possible to divide these financial institutions according to whether their business model is focused on buying or selling. In other words, whether they belong to the buy-side or the sell-side.

In the first case, they focus on investing in different products and acquiring different assets to increase their clients' wealth. In mergers and acquisitions, they advise companies wishing to purchase another company, establish a recommended price, and suggest financing alternatives.

In the second case, they are in charge of various sales transactions aimed at providing liquidity to their clients, such as, for example, IPOs or debt issuance. Again, during mergers and acquisitions, they search for potential buyers, acting as intermediaries and facilitating negotiations.

On the other hand, it is possible to differentiate three areas in any investment banking entity according to the activities carried out in them: the front office, the middle office, and the back office.

• Front office: This is where all tasks more strictly related to finance take place, such as trading in shares or other products, fund management, reporting and recommendations, company evaluation, and M&A consulting. This area is the closest to the client and communicates directly with them.
• Middle office: In this area, audits and risk management are performed, corporate strategies are designed, treasury work is carried out, and internal controls are implemented.
• Back office: Administration and accounting tasks resulting from the confirmation of a transaction are performed in the back office, the last of the areas where IT services are also developed.

A career with more participants

Although they share several aspects, investment banking and retail banking are entirely different worlds in terms of the target audience, the products that comprise their range of services, and the structure of the organizations themselves. And since the number of customers is smaller, resources are usually more optimized in the former, where there is more room to develop tailor-made services.

In any case, both are undergoing a radical transformation due to the emergence of the Internet. Like practically all sectors, these two types of banking are immersed in the leap to digitalization. And, unlike in the past, the bibs in this race are no longer so exclusive.

The rise of Fintechs and alternative financing platforms, such as Inversa Invoice Market, which often offer better conditions than conventional institutions, has substantially intensified competition. More and more individuals and companies are turning to these new channels to complement their investment strategies and meet their financing needs.