How Do Investment Bank Make Money?
Ever wonder how does Investment Banks make money? Let's see.
Before we being to look at how investment banks (IB) make money, lets first look at what IB are? IB according to different resources started in late 1800s or early 1900s. In the UK it is was called as Merchant Banking and in USA Investment Banking.
Investment Banks serve (but not limited to):
Ultra High Net-worth Individuals (UHNIs),
High Net-worth Individuals
Governments
Companies
Investment Banks provide (not an exhaustive list) following services:
Underwriting, Fund Raising (IPO, FPO)
Merger & Acquisition
Asset Management
Equity Research
Trading
Few ways in which IBs earn revenue are:
Underwriting - An underwriter promises to buy any bought shares of company which it assists to go public. Companies like JP Morgan, Goldman Sachs, BofA, Citibank, etc. offer this service. They on behalf of a company raise funding from investors via selling stocks or bonds. There are three types of underwriting - Firm Commitment, Best Efforts and All-or-None.
As per PWC, for a deal value ranging $25 million - $ 99 million, average underwriting fee percent is 7.0% and for a deal value of greater than $1 billion the average underwriting fee percent is around 3.5%. And as per the public filings the underwriting fees ranges between 3.5% to 7.0%.
Fund Raising (IPO, FPO, etc.) - It is process to make a company become public. IPO is known as Initial Public Offering and IPO happens in Capital Market’s primary market. Before going for IPO, as per PWC, 98% of organizations conduct IPO readiness check.
Merger & Acquisition(M&A) - M&A can be classified into buy and sell side. In M&A, acquisition is concerned with one company acquiring another company (make involve more than 1 company). Merger is concerned when one company merges with another.
Side note - outcomes of M&A are following, where in A acquire B and both exist or A acquires B and only A exist or A mergers with B and A/B exist or A merger with B and a new entity C is formed.
Trading and Selling - Investment Banks are also involved in trading and make revenue from this service. Unlike a retail investor, IBs trade in huge volume. IBs invest on behalf of their clients and also have their own trading desk .
Advisory - As per Statista, Goldman Sachs’ investment banking’s largest revenue share comes from advisory. In 2022, out of approx. $7.3 billion, around $4.7 billion came from advisory.
Securitisation - From commercial banks IBs buy pool of loans or assets (illiquid ones) and they break them into small pools to make then into marketable securities. An example of this is sub-prime mortgage in 2008.
Source: CFI, Statista, PWC, Managementstudyguide
What are your thoughts? What topic you want us to cover next time?