Investment Banking: What it Is & How it Works

Investment banking is a specialized sector within finance that facilitates complex financial transactions, capital raising, and advisory services for corporations, governments, and institutional investors. Investment banks maintain a crucial role in the global financial system, helping businesses expand, restructure, and access capital markets through equity and debt offerings. This guide explores the fundamentals of investment banking, its distinction from commercial banking, key players in the industry, and the responsibilities of investment bankers.

Read: How to Prepare for a Career in Investment Banking

What Is Investment Banking?

Investment banking refers to the business of providing financial advisory services, underwriting securities, and facilitating mergers and acquisitions for corporate clients. Unlike commercial banking, which focuses on accepting deposits and lending money to individuals and businesses, investment banking centers on structuring and executing complex deals that involve raising capital, initial public offerings (IPOs), and strategic advisory services.

Investment banks typically generate revenue through underwriting fees, trading commissions, and advisory services. These firms engage in financial modeling, risk management, and quantitative analysis to support clients in making informed investment decisions. The investment banking industry is highly competitive, with large investment banks such as JPMorgan Chase, Goldman Sachs, and Morgan Stanley dominating the market, while boutique investment banks focus on niche advisory services.

Types of Investment Banking

Investment banking is divided into different industry-specific groups that focus on distinct sectors. Some of the key divisions include:

Technology, Media, and Telecommunications (TMT)

Investment banks specializing in TMT investment banking work with companies in the technology, media, and telecommunications sectors. These bankers advise on mergers and acquisitions, IPOs, and capital raising for tech startups, social media platforms, and telecom giants. High-profile deals in this sector include Google's acquisition of YouTube and Facebook’s purchase of WhatsApp.

Healthcare Investment Banking

Healthcare investment banking focuses on pharmaceutical companies, biotech firms, hospitals, and medical device manufacturers. This division plays a crucial role in advising on regulatory challenges, drug development funding, and healthcare mergers, such as Pfizer’s acquisition of Wyeth and the CVS-Aetna merger.

Financial Institutions Group (FIG)

The Financial Institutions Group (FIG) serves banks, insurance companies, hedge funds, asset managers, and other financial service providers. FIG bankers assist with capital raising, restructuring, and regulatory compliance. Major transactions in this area include JPMorgan Chase’s acquisition of Bear Stearns during the 2008 financial crisis.

Real Estate Investment Banking

Real estate investment banking focuses on advising real estate developers, REITs (Real Estate Investment Trusts), and property management firms. These banks help finance commercial and residential real estate projects, issue mortgage-backed securities, and structure real estate acquisitions. Blackstone's real estate investments, such as its acquisition of Hilton Worldwide, exemplify the scale of deals in this sector.

Investment Banking vs. Commercial Banking

Investment banking and commercial banking serve different financial needs. Commercial banking primarily deals with deposit-taking, personal and business loans, and traditional banking services for individuals and businesses. In contrast, investment banking services cater to companies, institutional clients, and high-net-worth individuals seeking specialized financial solutions.

Key differences include:

• Capital Raising vs. Lending - Investment banks raise money for companies through stock market offerings and bond issuances, whereas commercial banks provide loans and credit lines.
• Institutional vs. Retail Focus - Investment banks advise clients such as hedge funds, private equity firms, and large corporations, while commercial banks serve everyday banking customers.
• Advisory Services vs. Traditional Banking - Investment banks provide advice on mergers and acquisitions, equity markets, and fixed income investments, while commercial banks focus on basic financial products like savings accounts and mortgages.

Both types of banks play essential roles in the economy, but investment banking is particularly important for businesses looking to expand, restructure, or enter new markets. Some of the largest investment banks in the world include Bank of America, Barclays Capital, Citigroup Investment Banking, Deutsche Bank, and JP Morgan.

Example:

An example scenario of an investment bank is if company A is thinking of buying company B. A is not sure how much B is worth or what the long-term financial situation looks like. In this case, an investment bank will be brought in to conduct due diligence in order to determine the value of company B, help negotiate terms of the deal, prepare documents, and advise on the timing. This investment bank is on the side of company A, but there may be other firms helping company B on the other side. The bigger the size of the deal, the more commission the bank will earn.

How Investment Banks Operate

Investment banks function through various divisions that handle different aspects of financial services:

• Investment Banking Division (IBD): Focuses on advisory services, capital raising, and mergers and acquisitions.
• Trading Division: Engages in buying and selling securities, including stocks, bonds, and other financial products.
• Research Division: Conducts equity research and market analysis to provide investment advice.
• Asset Management: Manages portfolios for institutional investors and high-net-worth individuals.

Investment banks also assist in financial modeling, balance sheet restructuring, and structuring financial instruments such as derivatives. These activities help corporations and governments optimize their capital structures and maximize value creation.

The Intermediary Role of Investment Banks

Investment banks are best known for their role as intermediaries, connecting corporations with financial markets. Their responsibilities include:

• Issuing Securities: Assisting companies in IPOs and secondary stock offerings.
• Debt Financing: Finding large institutional investors for corporate bonds.
• Mergers and Acquisitions (M&A): Advising on corporate transactions and structuring deals.

Investment banks also conduct pre-underwriting counseling and due diligence to ensure that transactions comply with regulatory requirements and market conditions. Their clients include corporations, pension funds, hedge funds, financial institutions, and governments.

Financial Advice

As financial advisors, investment banks provide strategic guidance to institutional investors. They leverage deep market knowledge, industry insights, and financial modeling to help clients navigate short-term and long-term investment opportunities and risks.

Mergers and Acquisitions

M&A advisory is a cornerstone of investment banking. Large investment banks, such as Goldman Sachs, JPMorgan Chase, and Morgan Stanley, work across multiple industries, while smaller firms, like Greenhill & Co. and Guggenheim Partners, specialize in niche markets such as healthcare.

Investment banks estimate the value of target companies, negotiate deal terms, and structure transactions to optimize shareholder value and regulatory compliance.

Research Division

Investment banks have dedicated research divisions that analyze companies and issue reports with buy, hold, or sell recommendations. While research does not directly generate revenue, it supports trading operations and provides investment advice to clients. The research division focuses on:

• Equity and Fixed-Income Research: Assessing financial markets and credit risk.
• Macroeconomic Analysis: Identifying global market trends.
• Quantitative Analysis: Applying data-driven models to forecast investment opportunities.

Criticism of Investment Banks

Investment banks serve external clients while also engaging in proprietary trading, creating potential conflicts of interest. To address this, regulatory measures such as ethical walls are implemented to prevent unfair advantages. Furthermore, compliance with fiduciary rules, such as the Retirement Security Rule, is enforced to protect investors from biased financial advice.

The Retirement Security Rule, issued by the U.S. Department of Labor in April 2024, establishes a higher fiduciary standard for advisors managing retirement accounts. The rule mandates that financial advisors prioritize clients' best interests, restricting certain investment products and services that may present conflicts of interest.

Examples of Investment Banking in Action

An example of investment banking can be seen in a merger and acquisition deal. In 2015, Heinz and Kraft Foods merged in a $49 billion deal, facilitated by investment banks including Lazard and Centerview Partners. These banks conducted due diligence, assessed company valuations, and structured the agreement to create one of the largest food companies in the world.

Another major deal was Disney’s $71.3 billion acquisition of 21st Century Fox in 2019, where JPMorgan Chase and Goldman Sachs acted as financial advisors. These investment banks provided guidance on pricing, regulatory hurdles, and financing options to ensure the transaction's success.

Additionally, investment banks help companies go public through an initial public offering (IPO). A prime example is Facebook’s IPO in 2012, where Morgan Stanley, JPMorgan Chase, and Goldman Sachs served as lead underwriters. They played a crucial role in setting the IPO price, marketing the shares to institutional investors, and managing the allocation process. More recently, Airbnb’s 2020 IPO saw Morgan Stanley and Goldman Sachs leading efforts to raise $3.5 billion, marking one of the largest IPOs in history.

These transactions require expertise in financial modeling and risk management to ensure successful execution, underscoring the vital role of investment banks in global finance.

The Role of Investment Bankers

Investment bankers work with corporate clients, governments, and institutional investors to structure deals, provide investment advice, and raise money through various capital markets. They specialize in equity research, financial modeling, and advising on mergers and acquisitions.

The career path within investment banking typically progresses from analyst to associate, vice president, senior banker, and eventually managing director. Large investment banks seek candidates with strong quantitative analysis skills, strategic thinking, and expertise in corporate finance.

Investment Management in Financial Institutions

Investment management plays a critical role within financial institutions, helping clients navigate a broad range of investment opportunities. These institutions, including banks, hedge funds, and asset management firms, offer investment management services to corporations, institutional investors, and high-net-worth individuals.

A broad range of financial products, including stocks, bonds, and alternative assets, are managed by investment professionals to optimize returns while mitigating risk. Financial institutions leverage investment management strategies to diversify portfolios, enhance value creation, and ensure long-term financial growth for their clients.

Through investment management, financial institutions also provide advisory services, portfolio analysis, and strategic asset allocation. This sector remains essential in global finance, shaping capital markets and influencing major economic trends.

Key Players in the Investment Banking Industry

The investment banking industry is dominated by firms such as:

• Goldman Sachs – A global leader in investment banking, trading, and asset management.
• JPMorgan Chase – Offers comprehensive investment banking services, including corporate finance and risk management.
• Morgan Stanley – Specializes in equity markets, financial products, and institutional investing.
• Barclays Capital – A key player in capital markets, mergers and acquisitions, and fixed income trading.

In addition to large firms, small investment banks and boutique investment banks focus on specialized advisory services, often catering to niche markets or regional deals.

Final Thoughts

Investment banking plays a huge role in global finance by facilitating complex financial transactions, providing investment banking services, and helping companies raise money through capital markets. From advising on mergers and acquisitions to managing financial instruments and conducting equity research, investment bankers are instrumental in shaping business strategies and economic growth.

For those aspiring to enter the investment banking business, gaining expertise in financial modeling, corporate finance, and risk management is essential. The industry remains highly competitive, with Wall Street firms and international banks continuing to lead in new business development and market expansion.

To learn more about investment banking, explore additional resources on wealth management, corporate finance, and career preparation in this lucrative field:

• Wealth Management vs. Investment Banking: Key Differences and Career Prospects
• Top Ten Investment Banks
• The Best MBA Programs for Investment Banking
• How to Break Into Investment Banking–What to Do From Freshman to Senior Year
• 35+ Free Resources to Break into Investment Banking
• How to Prepare for a Career in Investment Banking

How Top Investment Coaches Can Guide You

Navigating the investment banking industry can be challenging, but top investment coaches provide invaluable insights into breaking into the field and excelling in various roles. These experts offer guidance on resume building, interview preparation, financial modeling training, and career progression strategies. By leveraging their experience and industry knowledge, aspiring investment bankers can gain a competitive edge, develop strong technical skills, and make informed career decisions that align with their professional goals.

FAQs

What does an investment banker actually do?

• Investment Bankers are investment professionals who combine financial services industry expertise, analytical prowess, and effective persuasive communication skills to support institutional clients in activities like capital raising and mergers and acquisitions.

Read: What Do Investment Banks Actually Do?

What is the main function of investment banks?

• In essence, investment banks are a bridge between large enterprises and investors. Their primary roles are to advise businesses and governments on how to meet their financial challenges and to help them procure financing, whether it be from stock offerings, bond issues, or derivative products.

What are the 4 pillars of investment banking?

• In summary, The Four Pillars of Investing is an important tool for investors looking to design a more successful investment portfolio. Investors can make better financial decisions by comprehending the four pillars of theory, history, psychology, and business.

How do investment banks make money?

• Investment banks generate revenue and earn profits by charging fees and commissions for their services, including underwriting securities, providing M&A advisory, and executing trades for institutional clients.

Who pays the investment banker?

• Overall, investment banking is a lucrative field that requires a deep understanding of finance, strong analytical skills, and excellent interpersonal abilities. “Why investment banking” is not a hard question for many for this reason. Investment bankers make money through the fees charged to their clients.

Which degree is best for investment banking?

• For those seeking a career in investment banking, a bachelor's degree in finance is a prerequisite. Other potentially acceptable majors include a bachelor's in economics or a bachelor's in business supplemented with a minor in finance

Who are the clients of investment banks?

• Rather than working with individuals, investment banks primarily work with large corporations and government agencies. The role of an investment bank is two-fold – either selling or buying.

What do you need to know for investment banking?

• The skills required to work in investment banking are a combination of technical skills (e.g., financial modeling, valuation, market research) and soft skills (e.g., time management, effective communication).

What is an investment banking job?

• Investment bankers help their clients raise money in capital markets by issuing debt or selling equity in the companies. Other job duties include assisting clients with mergers and acquisitions (M&As) and advising them on unique investment opportunities such as derivatives.

What is the difference between PE and investment banking?

• Private equity (PE) firms focus on acquiring and improving companies, whereas investment banks specialize in raising capital and managing significant financial transactions. Read on to uncover the key differences, unique roles, and strategies of these financial powerhouses and discover what sets them apart.