Investment Banking
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Industry Overview
The investment banking industry in the US is comprised of approximately 3,000 companies, with combined annual revenue of about $100 billion. Major companies include Morgan Stanley and Goldman Sachs. Investment banking is heavily concentrated: the largest 50 firms hold 90 percent of the market. The industry continues to consolidate.
Competitive Landscape
Demand is driven by economic activity that results in company mergers, acquisitions, or public financing. The profitability of an investment bank depends on its ability to accurately assess both the value of a business transaction and the readiness of the market to buy the attendant debt or equity. Big firms have an advantage because large customer transactions require firms with substantial financial resources. Small investment banks can compete by participating in syndications and operating in regional markets or specialized industries. Although labor-intensive, the industry produces very high value: average annual revenue per employee at large firms is under $1 million.
The global financial crisis of 2008-2009 dramatically altered the landscape of the investment banking industry. Morgan Stanley and Goldman Sachs, the only large firms still intact, have changed their status from investment banks to bank-holding companies. Both firms still engage primarily in investment banking, but former industry leaders such as Bear Stearns, Merrill Lynch, and Lehman Brothers have either been acquired or have filed for bankruptcy protection. The demise of these firms and the late 2000s recession have likely ushered in a new era in which the creation of innovative but risky financial instruments will be replaced by more traditional banking services. The new environment also means more industry oversight by the federal government, which had to step in and bail out dozens of financial services firms with billions of dollars of taxpayers' money.
Products, Operations & Technology
The primary revenue sources of the investment banking industry are from actively trading financial instruments, providing asset management services for wealthy clients and retirement and investment funds, placing new debt and equity issues with public and private investors, and from fees associated with M&As. Investment banks also buy new debt and equity issues for their own accounts, acting as the market "maker," and are active securities and currency traders. Of industry revenue, approximately 50 percent comes from trading; 35 percent from asset management and securities services; and 15 percent from M&A fees and public offerings.
The industry assembles and supplies the capital required by businesses to expand, merge, and acquire other businesses. Investment banks are intermediaries between corporations issuing new debt and equity securities and investors that buy the securities. An investment bank buys new securities from the issuing company at a negotiated price and resells them to its investor base, other investment banks, and the investing public. This arrangement, called underwriting, allows the investment bank to assume the risk of the new issue for a profit on the difference between the purchase price and the offer price. The investment bank may act as the maker of the market for the new securities, facilitating trades between buyers and sellers. Investment banks perform a variety of other financial services, such as M&A advice and market analysis.
The major investment banks have research staff that performs the risk, economic, and financial analysis used to support internal operations, from acquisitions and mergers to formulating trading positions in world, US, and regional markets. The profitability of an investment bank is directly related to the quality of its research analysis. Big investment banks employ a large number of salespeople, analysts, and traders in a network of offices, and may operate a trading floor. Smaller banks operate out of regular offices. Labor is the chief operating expense, with employees at top firms easily earning six figure salaries, on average.
Investment banks use cutting-edge communication and computing technology to support their operations. Dedicated, fully redundant, high-speed networks interconnect all major offices (domestic and foreign). Computing facilities and critical data are distributed among operations and backup sites. Backup facilities can be placed in service automatically in real-time without loss of data. Within a few days of 9/11, trading and support operations resumed when the markets reopened using backup facilities without loss of customer data.
