Download - Banking Styles
INVESTMENT BANKING
An investment bank is a financial institution that assists corporations and governments
in raising capital by underwriting and acting as the agent in the issuance of securities.
An investment bank also assists companies involved in mergers and
acquisitions, divestitures, etc. Further to provide ancillary services such as market
making and the trading of derivatives, fixed income instruments, foreign
exchange, commodity, and equity securities.
Unlike commercial banks and retail banks, investment banks do not take deposits.
To provide investment banking services in the United States an advisor must be a
licensed broker-dealer. The advisor is subject to Securities & Exchange
Commission (SEC) (FINRA) regulation. Until 1999, the United States maintained a
separation between investment banking and commercial banks. Other industrialized
countries, including G7 countries, have not maintained this separation historically.
Trading securities for cash or securities (i.e., facilitating transactions, market-making), or
the promotion of securities (i.e., underwriting, research, etc.) was referred to as the "sell
side".
Dealing with the pension funds, mutual funds, hedge funds, and the investing public
who consumed the products and services of the sell-side in order to maximize their
return on investment constitutes the "buy side". Many firms have buy and sell side
components.
Main activities and units
An investment bank is split into the so-called front office, middle office, and back office.
While large full-service investment banks offer all of the lines of businesses, both sell
side and buy side, smaller sell side investment firms such as boutique investment
banks and small broker-dealers will focus on investment banking and
sales/trading/research, respectively.
Investment banks offer security to both corporations issuing securities and investors
buying securities. Corporations’ investment bankers offer information on when and how
to place their securities in the market. The corporations do not have to spend on
resources with which it is not equipped. To the investor, the responsible investment
banker offers protection against unsafe securities. The offering of a few bad issues can
cause serious loss to its reputation, and hence loss of business. Therefore, investment
bankers play a very important role in issuing new security offerings.
Core Banking Activities
Investment banking is the traditional aspect of the investment banks which also
involves helping customers raise funds in the capital markets and giving advice
on mergers and acquisitions. Investment banking may involve subscribing investors
to a security issuance, coordinating with bidders, or negotiating with a merger target.
Another term for the investment banking division is corporate finance, and its
advisory group is often termed mergers and acquisitions (M&A). A pitch book of
financial information is generated to market the bank to a potential M&A client; if the
pitch is successful, the bank arranges the deal for the client. The investment banking
division (IBD) is generally divided into industry coverage and product coverage
groups. Industry coverage groups focus on a specific industry such as healthcare,
industrials, or technology, and maintain relationships with corporations within the
industry to bring in business for a bank. Product coverage groups focus on financial
products, such as mergers and acquisitions, leveraged finance, project finance,
asset finance and leasing, structured finance, restructuring, equity, and high-grade
debt and generally work and collaborate with industry groups in the more intricate
and specialized needs of a client.
Sales and trading: On behalf of the bank and its clients, the primary function of
a large investment bank is buying and selling products. In 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, which can price and execute
trades, or structure new products that fit a specific need. Structuring has been a
relatively recent activity 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. Strategists advise external as well as internal clients on the strategies that
can be adopted in various markets. Ranging from derivatives to specific industries,
strategists place companies and industries in a quantitative framework with full
consideration of the macroeconomic scene. This strategy often affects the way the
firm will operate in the market, the direction it would like to take in terms of its
proprietary and flow positions, the suggestions salespersons give to clients, as well
as the way manufacturers create new products. Banks also 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. The
necessity for numerical ability in sales and trading has created jobs for physics, math
and engineering Ph.Ds. who act as quantitative analysts.
Research is the division which reviews companies and writes reports about their
prospects, often with "buy" or "sell" ratings. While the research division may or may
not generate revenue (based on policies at different banks), its resources are used
to assist traders in trading, the sales force in suggesting ideas to customers, and
investment bankers by covering their clients. Research also serves outside clients
with investment advice (such as institutional investors and high net worth individuals)
in the hopes that these clients will execute suggested trade ideas through the Sales
& Trading division of the bank, thereby bringing in revenue for the firm. There is a
potential conflict of interest between the investment bank and its analysis in that
published analysis can affect the profits of the bank. Therefore in recent years the
relationship between investment banking and research has become highly regulated
requiring a Chinese wall between public and private functions.
Size of Industry
Global investment banking revenue increased for the fifth year running in 2007, to $84.3
billion. This was up 22% on the previous year and more than doubles the level in 2003.
Despite a record year for fee income, many investment banks have experienced large
losses related to their exposure to U.S. sub-prime securities investments.
The United States was the primary source of investment banking income in 2007, with
53% of the total, a proportion which has fallen somewhat during the past decade.
Europe (with Middle East and Africa) generated 32% of the total, slightly up on its 30%
share a decade ago. Asian countries generated the remaining 15%. Over the past
decade, fee income from the US increased by 80%. This compares with a 217%
increase in Europe and 250% increase in Asia during this period. The industry is heavily
concentrated in a small number of major financial centers, including London, New York
City, Hong Kong and Tokyo.
Investment banking is one of the most global industries and is hence continuously
challenged to respond to new developments and innovation in the global financial
markets. New products with higher margins are constantly invented and manufactured
by bankers in hopes of winning over clients and developing trading know-how in new
markets. However, since these can usually not be patented or copyrighted, they are
very often copied quickly by competing banks, pushing down trading margins.
For example, trading bonds and equities for customers is now a commodity
business, but structuring and trading derivatives retains higher margins in good times—
and the risk of large losses in difficult market conditions, such as the credit crunch that
began in 2007. Each over-the-counter contract has to be uniquely structured and could
involve complex pay-off and risk profiles. Listed option contracts are traded through
major exchanges, such as the CBOE, and are almost as commoditized as general
equity securities.
In addition, while many products have been commoditized, an increasing amount of
profit within investment banks has come from proprietary trading, where size creates a
positive network benefit (since the more trades an investment bank does, the more it
knows about the market flow, allowing it to theoretically make better trades and pass on
better guidance to clients).
The fastest growing segment of the investment banking industry is private investments
into public companies (PIPEs, otherwise known as Regulation D or Regulation S). Such
transactions are privately negotiated between companies and accredited investors.
These PIPE transactions are non-rule 144A transactions. Large bulge
bracket brokerage firms and smaller boutique firms compete in this sector. Special
purpose acquisition companies (SPACs) or blank check corporations have been created
from this industry.
CENTRAL BANKING
Creating a Central Bank for the Philippines
A group of Filipinos had conceptualized a central bank for the Philippines as early as
1933. It came up with the rudiments of a bill for the establishment of a central bank for
the country after a careful study of the economic provisions of the Hare-Hawes Cutting
bill, the Philippine independence bill approved by the US Congress.
During the Commonwealth period (1935-1941), the discussion about a Philippine
central bank that would promote price stability and economic growth continued. The
country’s monetary system then was administered by the Department of Finance and
the National Treasury. The Philippines was on the exchange standard using the US
dollar—which was backed by 100 percent gold reserve—as the standard currency.
In 1939, as required by the Tydings-McDuffie Act, the Philippine legislature passed a
law establishing a central bank. As it was a monetary law, it required the approval of the
United States president. However, President Franklin D. Roosevelt disapproved it due
to strong opposition from vested interests. A second law was passed in 1944 during the
Japanese occupation, but the arrival of the American liberalization forces aborted its
implementation.
Shortly after President Manuel Roxas assumed office in 1946, he instructed then
Finance Secretary Miguel Cuaderno, Sr. to draw up a charter for a central bank. The
establishment of a monetary authority became imperative a year later as a result of the
findings of the Joint Philippine-American Finance Commission chaired by Mr. Cuaderno.
The Commission, which studied Philippine financial, monetary and fiscal problems in
1947, recommended a shift from the dollar exchange standard to a managed currency
system. A central bank was necessary to implement the proposed shift to the new
system.
Immediately, the Central Bank Council, which was created by President Manuel Roxas
to prepare the charter of a proposed monetary authority, produced a draft. It was
submitted to Congress in February1948. By June of the same year, the newly-
proclaimed President Elpidio Quirino, who succeeded President Roxas, affixed his
signature on Republic Act No. 265, the Central Bank Act of 1948. The establishment of
the Central Bank of the Philippines was a definite step toward national sovereignty.
Over the years, changes were introduced to make the charter more responsive to the
needs of the economy. On 29 November 1972, Presidential Decree No. 72 adopted the
recommendations of the Joint IMF-CB Banking Survey Commission which made a
study of the Philippine banking system. The Commission proposed a program designed
to ensure the system’s soundness and healthy growth. Its most important
recommendations were related to the objectives of the Central Bank, its policy-making
structures, scope of its authority and procedures for dealing with problem financial
institutions.
Subsequent changes sought to enhance the capability of the Central Bank, in the light
of a developing economy, to enforce banking laws and regulations and to respond to
emerging central banking issues. Thus, in the 1973 Constitution, the National Assembly
was mandated to establish an independent central monetary authority. Later, PD 1801
designated the Central Bank of the Philippines as the central monetary authority (CMA).
Years later, the 1987 Constitution adopted the provisions on the CMA from the 1973
Constitution that were aimed essentially at establishing an independent monetary
authority through increased capitalization and greater private sector representation in
the Monetary Board.
The administration that followed the transition government of President Corazon C.
Aquino saw the turning of another chapter in Philippine central banking. In accordance
with a provision in the 1987 Constitution, President Fidel V. Ramos signed into law
Republic Act No. 7653, the New Central Bank Act, on 14 June 1993. The law provides
for the establishment of an independent monetary authority to be known as the Bangko
Sentral ng Pilipinas, with the maintenance of price stability explicitly stated as its
primary objective. This objective was only implied in the old Central Bank charter. The
law also gives the Bangko Sentral fiscal and administrative autonomy which the old
Central Bank did not have. On 3 July 1993, the New Central Bank Act took effect.
A central bank, reserve bank, or monetary authority is a banking institution granted
the exclusive privilege to lend a government its currency. Like a normal commercial
bank, a central bank charges interest on the loans made to borrowers, primarily the
government of whichever country the bank exists for, and to other commercial banks,
typically as a 'lender of last resort'. However, a central bank is distinguished from a
normal commercial bank because it has a monopoly on creating the currency of that
nation, which is loaned to the government in the form of legal tender. It is a bank that
can lend money to other banks in times of need. Its primary function is to provide the
nation's money supply, but more active duties include controlling subsidized-
loan interest rates, and acting as a lender of last resort to the banking sector during
times of financial crisis (private banks often being integral to the national financial
system). It may also have supervisory powers, to ensure that banks and other financial
institutions do not behave recklessly or fraudulently.
Much richer countries today have an "independent" central bank, that is, one which
operates under rules designed to prevent political interference. Examples include
the European Central Bank (ECB) and the Federal Reserve System in the United
States. Some central banks are publicly owned, and others are privately owned. For
example, the United States Federal Reserve is a quasi-public corporation.
History
In Europe prior to the 17th century most money was commodity money, typically gold or
silver. However, promises to pay were widely circulated and accepted as value at least
five hundred years earlier in both Europe and Asia. The medieval European Knights
Templar ran probably the best known early prototype of a central banking system, as
their promises to pay were widely regarded, and many regard their activities as having
laid the basis for the modern banking system.
As the first public bank to "offer accounts not directly convertible to coin", the Bank of
Amsterdam established in 1609 is considered to be a precursor to a central bank. In
1664, the central bank of Sweden - "Sveriges Riksbank" or simply "Riksbanken" - was
founded in Stockholm, in this time named "Stockholms Banco", and is by that the
world's oldest central bank (still operating today). This was followed in 1694 by the Bank
of England, created by Scottish businessman William in the City of London at the
request of the English government to help pay for a war.
Although central banks today are generally associated with fiat money, the nineteenth
and early twentieth centuries central banks in most of Europe and Japan developed
under the international gold standard, elsewhere free banking or currency boards were
more usual at this time. Problems with collapses of banks during downturns, however,
was leading to wider support for central banks in those nations which did not as yet
possess them, most notably in Australia.
With the collapse of the gold standard after World War I, central banks became much
more widespread. The US Federal Reserve was created by the U.S. Congress through
the passing of the Glass-Owen Bill, signed by President Woodrow Wilson on December
23, 1913, whilst Australia established its first central bank in 1920, Colombia in
1923, Mexico and Chile in 1925 and Canada and New Zealand in the aftermath of
the Great Depression in 1934. By 1935, the only significant independent nation that did
not possess a central bank was Brazil, which developed a precursor thereto in 1945 and
created its present central bank twenty years later. When African and Asian countries
gained independence, all of them rapidly established central banks or monetary unions.
The People's Bank of China evolved its role as a central bank starting in about 1979
with the introduction of market reforms in that country, and this accelerated in 1989
when the country took a generally capitalist approach to developing at least its export
economy. By 2000 the People's Bank of China was in all senses a modern central bank,
and emerged as such partly in response to the European Central Bank. This is the most
modern bank model and was introduced with the euro to coordinate the European
national banks, which continue to separately manage their respective economies other
than currency exchange and base interest rates.
Activities and Responsibilities
Functions of a central bank (not all functions are carried out by all banks):
implementing monetary policy
determining Interest rates
controlling the nation's entire money supply
the Government's banker and the bankers' bank ("lender of last resort")
managing the country's foreign exchange and gold reserves and the
Government's stock register
regulating and supervising the banking industry
setting the official interest rate – used to manage both inflation and the
country's exchange rate – and ensuring that this rate takes effect via a variety of
policy mechanisms
Central banks implement a country's chosen monetary policy. At the most basic
level, this involves establishing what form of currency the country may have,
whether a fiat currency, gold-backed currency (disallowed for countries with
membership of the IMF), currency board or a currency union. When a country
has its own national currency, this involves the issue of some form of
standardized currency, which is essentially a form of promissory note: a promise
to exchange the note for "money" under certain circumstances. Historically, this
was often a promise to exchange the money for precious metals in some fixed
amount. Now, when many currencies are fiat money, the "promise to pay"
consists of nothing more than a promise to pay the same sum in the same
currency.
In many countries, the central bank may use another country's currency either
directly (in a currency union), or indirectly, by using a currency board. In the latter
case, local currency is directly backed by the central bank's holdings of a foreign
currency in a fixed-ratio; this mechanism is used, notably, in Bulgaria, Hong
Kong and Estonia.
In countries with fiat money, monetary policy may be used as a shorthand form
for the interest rate targets and other active measures undertaken by the
monetary authority.
UNIVERSAL BANKING
A universal bank participates in many kinds of banking activities and is both
a Commercial bank and an Investment bank.
The concept is most relevant in the United Kingdom and the United States, where
historically there was a distinction drawn between pure investment
banks and commercial banks. In the US, this was a result of the Glass-Steagall Act of
1933. In both countries, however, the regulatory barrier to the combination of
investment banks and commercial banks has largely been removed, and a number of
universal banks have emerged in both jurisdictions. However, at least up until the global
financial crisis of 2008, there remained a number of large, pure investment banks.
In other countries, the concept is less relevant as there is not regulatory distinction
between investment banks and commercial banks. Thus, banks of a very large size
tend to operate as universal banks, while smaller firms specialized as commercial banks
or as investment banks. This is especially true of countries with
a European Continental banking tradition. Notable examples of such universal banks
include Deutsche Bank of Germany, and UBS and Credit Suisse of Switzerland.