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The changing opportunities and challenges of investment banking

With profits eroding and technology absorbing the financial services, Investment Banking needs to re-establish its niche. Focusing on core activities, customer engagement and technology incorporation is vital for a chance at continued relevance in the financial sector.

Jul 7, 2019 |
7 min read

The uncertainty and competitiveness of the financial markets today is exceptional. Security, communication, and analyses are becoming increasingly digitized. The rapid growth of technologies has especially disrupted the investment banking sector.

Once a traditional industry comprised of private partnerships and specific markets, investment banking needs to reinvent their relevance. Despite my confidence in the longevity of investment banking, stakeholders cannot ignore the stagnant profits and declining revenues.

Moving forward, investment banks need a solid grasp of investment banking’s dynamics.

What is investment banking?

Simply, Investments banks operate as intermediaries between entities which need capital and entities which have money to invest.

Mergers and acquisitions consultancy

Investment banking provides financial support in two key areas. The first is providing consultancy services for mergers & acquisition. This comprises of conducting effective negotiations on the structure, valuation, financing, and implementation of the M&A strategy.

Consider the example of a retail giant with the strategic objective of acquiring a wholesale business. Investment banking facilitates the search for the most appropriate target business and initiates negotiations.

Based on financial and market expertise, an investment banker explains the feasibility of this strategy. Investment banking uses analyses and forecasts to highlight how capital will be in the best interest of both parties.

Another example is of a luxury chocolate bar producer seeking business growth. Investment banking institution aims for a merger with a large FMCG producer by explaining how FMCG’s brand line will enhance.

In the two examples, the retailer had money to spend while the chocolate bar producer needed capital and strategy support for further growth. Investment banking work to help both achieve the most financially and strategically viable solutions.

Capital underwriting

The second area of investment banking is providing underwriting services. This is the process of raising finance by either selling stocks or bonds on behalf of the client. Generally, investment banking does well when the economy is performing well.

Economic growth and prosperity mean investors have more money to spend. Such markets fuel the “buy side” for the investment banks.

Investment banking services can be a part of a larger bank. A full-service investment bank can operate on its own.

The latter provides services extending to the sales & trading of securities, asset management and equity research on top of the underwriting and M&A consultancy that an investment banking division typically offers.

Clients of investment banks include governmental organizations as well as corporations.

Key trends of investment banking in 2019

With Lehman Brother filing for bankruptcy in 2008, investment banking has gone through a tough patch of the business cycle. A research study by Goldberg et al., (2018) reported the first growth in trading and advisory revenues in 2018 since 2012.

According to a report on the banking industry outlook by Deloitte, 2019 could be a pivotal year for investment banks. “Investment banking is transitioning towards simpler and leaner, yet stronger, franchises.” This article highlights some of the key trends in investment banking below:

Specialization based client engagement

With increasing competition, investment banks need to adopt strategic and fundamental thinking of client engagement (Deloitte, 2019). This requires the delivery of services, solution structures, and product orientation to be client-centric.

Intelligent investment banking perfectly understands the businesses itself and not just its finance. Realizing the value of brand name, corporate image, and strategic sync is critical. This is true for both corporations and governmental institutions taking investment banking services.

Effective investment banking aims for client empowerment rather than completing a financial transaction.

Shift in the balance of power

Customer Service. Express Delivery. Customer Relationship Management. These are the terms that define businesses today, and investment banking has not been able to avoid the trend.

A report by Hoffman (2018) highlights that “Profits, assets, and influence have moved from investment banks like Goldman Sachs to money-management giants like BlackRock and Vanguard, the asset managers collectively known as the ‘buy side’.”

Those who purchase the services now hold power in finance. Why is this bad for investment banking? Because traditionally, investment banks operate on the ‘sell side’ (Corporate Finance Institute, 2019).

Greater price competition, growth of the markets, and commoditization have boosted client’s negotiation powers. This has made providing consultancy service a challenge for investment banking.

Stringent regulations and rising operational costs

Business strategies previously spanning for 5 years now have an implementation timeline of a year or six months. Everything has become fast-paced, leaving businesses and institutions in the quest for more capital.

News of financial scams and the ever-growing FinTech market has further raised uncertainty. Together the trends have given rise to multiple waves of regulations such as PSD2 and MiFID.

Governance outlined in BCBS239 is now being adhered to as a compliance requirement by regulators rather than a set of principles. As a result, investment banking faces increased pressures of optimization, accuracy, and costs. This has also increased the complexity of reporting.

Money-making business

Investment banking was once considered a money-making business. Investment bankers were believed to have handsome salaries, essential contacts, and lavish lifestyles. Several people entered the field with these attractions.

Economic and financial challenges, however, have impacted investment banking performance. Investment banks, big or small, division or full serviced are now under strict regulations and substantial operational costs. Traditional investment banking models in the current market cannot achieve success.

There is a critical need for re-balancing of priorities, goals, and future resources.

Sources of services and revenues for investment banking

Let me say this. I have always been a believer in new forms of money, especially technology-based money. But the way cryptocurrency has changed the view of capital acquisition, money management, and capital mobility, is definitely amazing.

Recently, the world’s largest banks have combined resources to develop new forms of currency. These will not only speed up the settlements but also free billions of dollars in capital.

Jacob Morgan, the founder of “the Future If” community and a best-selling author, compares the past and future of investment banking.  Morgan suggests that investment banks adapt to cryptocurrencies and turn to FinTech’s for support.

Increased transparency in investment banking is crushing possibilities of arbitrage and commission. Finding new sources of revenues is vital to the continued existence of investment banking.

Technology, Technology, Technology

Yes, that’s how important it is going forward. Top executives of all organizations, have one thing constantly on their minds: how can their businesses use technology for greater returns?

Adoption of technology also means that investment banking needs to rethink talent management. Automation is leading to the creation of more managerial roles, and the elimination of transactional tasks. Research by Morgan (2017) highlights 45% of financial professionals to be stressed. And, only 22% to be satisfied with their work-life balance.

How is investment banking supposed to deliver with half its employees stressed out and almost 80% dissatisfied? Expecting superior, creative, and breakthrough performance with these statistics is unfair. Investment banks can reduce headcount and manage talent through effective technology incorporation.

Furthermore, robo-advisors can guide investment banking decisions, AI, and automation can yield unparalleled analysis.  Lastly, confidence in privacy and security can be augmented through technological advancements.

Blockchains

Another area with impacts on investment banking is the blockchain technology. The PwC director of FinTech and digital EMEA, Seamus Cushley, reports a $1.4 billion investment in blockchain in just 2016.

This is expected to reach 12 billion per annum by 2025. A possible challenge for investment banking is how the blockchain technology can be the new middleman for financial transactions. Businesses benefit from it because they will have less commission to pay. Investment banking, as a result, can quickly become an avoidable expense.

How to deal with the changes in investment banking?

The world we live in today is highly complex. Organizations, products, and ideas are modeled using matrix systems. Managers deal with a vast array of factors and implications. Interestingly one of the best ways forward for investment banking is to simplify the path. This would present a sharper focus on client-product-solution matrix (Deloitte, 2019).

It is crucial to have a crystal clear view on three questions:

  • i) who to serve
  • ii) what to offer
  • iii) how to achieve it?

This is the direction investment banking should adopt.

Specialization is a key and much-desired trend amongst investors and capital seekers. Investment banking should focus on core activities and collaboration with third parties. The expansive growth of technology is both an opportunity and a challenge for investment banking.

Product and service mixes should incorporate AI, blockchain, robotics, and security technology.  Investment banking can offer technologies such as consumer portals, peer-to-peer digital models, and cloud solutions (SG Analytics, 2017).

This will help in uncovering new streams of revenue. Also, enhancing the much sought after client satisfaction.  Technology needs to be a part of the mix that investment banking offers rather than being a substitute for it.

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