FIN – 509

Investment Banking
 Learning Outcomes
• To study investment banking in Indian context

• Portfolio of investment banks

History of investment banking
in India
• The history of investment banking in India
traces back to when European merchant
banks first established trading houses in
the region in the 19th century. 
• Since then, foreign banks (non-Indian)
have dominated investment and merchant
banking activities in the country.
• In the 1970’s, the State bank of India
entered the business by creating the
Bureau of Merchant Banking and ICICI
Securities became the first Indian financial
institution to offer merchant banking
services.
• By 1980, the number of merchant banks
had risen to more than 30. This growth in
the financial services industry included
rapid expansion of commercial banks and
other financial institutions.
 Association of Investment
Bankers of India
• According to the Association of Investment
Bankers of India (AIBI), the merchant
banking industry started to take off in the
1990’s with over 1,500 merchant bankers
registering with the Securities and
Exchange Board of India (SEBI). 
 Purpose
• AIBI’s purpose is to ensure members
institutions follow its ethical and legal
practices, as well as to promote the
industry of investment banking in India and
the business interests of its members.
 Website exploration
• http://www.aibi.org.in/
Portfolio of an Investment Bank
• Globally, Investment banks handle
significant fund-based business of their
own in the capital market along with their
non-fund services portfolio which is offered
to clients.
• However, these distinct segments are
handles either on the same balance sheet
or through subsidiaries and affiliates
depending upon the regulatory
requirements in the operating environment
of each country.
• All these activities are segmented across
three broad platforms-

– equity market activity

– debt market activity
– merger and acquisitions
• In addition, given the structure of the
market there is also a segmentation based
on whether a particular investment bank
belongs to a banking parent or is a stand-
alone pure investment bank.
• Though investment banks also earn a
significant component of their income from
non-fund based activity, it is their capacity
to support the clients with fund-based
services, which distinguishes them from
pure merchant banks.
 Example
• In US capital market, investment banks
underwrite the issues or buy them outright
(i.e.wholesale basis) and sell them later to
retail investors thereby taking upon
themselves significant financial exposure
to client companies.
Different positions of Investment
banks
• the global investment banks plays a major
role as institutional investors in trading
and having large holdings of capital
market securities.
• As a dealer, they take the positions and
make a market for many securities both in
equity and derivatives segments. They
hold large inventories and therefore
influences the direction of market
• Some investment banks in overseas
markets also specialize in other segments
such as management of hedge funds,
bullion trade, commodity hedges, real
estate and other exotic markets.
Investment Banking in India

 Its existence has been traced to over 3 decades.

 IB was largely confined to MB services.
 The forerunners of Merchant banking in India were mostly foreign
banks.
 In 1972 T he Banking commission Report asserted the need for
Merchant banking Services in India.
 Here merchant banking was meant to provide advisory services
and manage investments.
 By the mid eighties and early nineties, most of the merchant
banking divisions of public sector banks were spun-off as separate
subsidiaries. This includes SBI’s SBI capital markets Ltd in 1986
and IDBI’s IDBI capital markets in 1992.
Growth:

 Merchant banking activity was regulated by SEBI in 1992

following a sever downturn due to phases of hectic activity in
business.
 Majority of those registered under SEBI were either in Issue
management or advisory services.
 Based on their net-worth, SEBI had 4 categories of Merchant
banks.
 The number of registered merchant banks with SEBI at the end of
march 2003 was 124 from a high of almost a thousand in nineties.
 In 2002-03 the number further decreased by 21.
Constraints to IB

 Over dependence in the Issue management activity in the initial

years led the merchant banks to perish in the primary market
downturn. Later they diversified to offer a broad spectrum of
capital market services.
 Only few industry leaders other than merchant banks could not
turn themselves into full service investment banks.
 Indian industry has seen more or less similar developments to that
of its western counterparts, though the breadth available there is
still not present in India.
 Due to lower availability of institutional financing to fund the
capital market activity, its only the bigger industry players who are
in full service investment banking.
 The main constraint is the inadequate breadth in the secondary
market, especially in the corporate debt segment.
Risk aversion, characteristics and structure of Indian Investment Banking
Industry

Indian regulatory regime does not allow all investment banking functions to
be performed under one legal entity as its structure over the years has
evolved due to business realities and the regulatory regime. The reasons for
this are:
1. To prevent excessive risk exposure to business risk under one entity &
2. To prescribe and monitor capital adequacy and risk mitigation
mechanisms.

Thus Indian investment banks follow a conglomerate structure by keeping

their business segments in different corporate entities to meet regulatory
norms.
Indian investment banking industry also has a heterogeneous structure, as
bigger investment banks have several group entities in which the core and
non-core business segments are distributed. Others have one or more
entities depending upon the activity profile.
Inter-dependence between different verticals in investment banking

There are different verticals in investment banking and they do enjoying synergies with one another. The
service or business segments form the core of investment banking, others provide invaluable support. It
is important to understand and the inter-dependence and complementary existence of all these business
segments.

 Merchant banking largely relates to management of public floatation of securities/ reverse floatation
like buy backs and open offers, underwriting is an inherent part of MB for public issues.
 Advisory and transaction services have a close linkage with MB in public issue and reverse
floatation.
 Venture capital enables identification of potential IPO candidates which leads to generation of fee
income from MB services and good capital gain for the VC invested at the earlier rounds of financing
in such companies.
 Stock broking and primary dealership in debt markets nurture- institutional, corporate and retail
clients who can be tapped effectively for asset management,, PF management, and private equity
business.
 Presence in the equity derivative and foreign exchange derivative segments can help in offering
solutions in treasury management to clients.

All these verticals are driven by support services such as sales and distribution and equity research
and analysis, where the capability of S&D determines the success of MB vertical.

Thus IB is a business that is very sensitive to the economic and capital market scenario and therefore,
the broader the platform of operations, the more is the likelihood of an IB, surviving business cycles
and sudden shocks from the market.
Conflict of interest in IB

The most burning global issue in the IB industry at the beginning of the 21 st century became the conflict
of interest between the investment banks and their research analysis divisions.

 The securities and exchange commission in the US initiated investigations into instances of investment
banks issuing over-optimistic research and steering in hot IPO’s for important clients in vested
interests.

 In such investigations some banks were also fined.

How does the conflicts arise?

 Most investment banks have in-house research divisions as a support function. The
research divisions perform vital functions of tracking corporate and making
recommendations to their clients in the secondary market operations or to their own dealing
rooms. They also issue reviews and ratings to the new issuances hitting the market.

 The conflict could arise if the analyst would promote a share, the public offering for which is
being handled by the MB.

 Alternatively , it could also be that the analyst is prone to insider information from the
merchant banking division and there upon issue recommendations that could amount to
fraudulent deceit of investors or gain for select few.
The corporate scandals of US led to precautionary amendments in India by SEBI.

SEBI amended the regulations that were in place for merchant bankers and Underwriters and for
prohibition of insider trading . As a result analysts are barred from private trading in shares they
analyze.

There is rule for more regulation in this area of importance for the survival of the IB industry.
Full service investment banks and financial conglomerates of the future.

 The business of IB is under-going rapid changes in response to the growing sophistication in the
financial markets and the need of clients.

 Consolidation and globalization is the ‘Mantra’ for success and growth.

 Financial conglomerates with equal presence and reach in commercial banking, IB, insurance
and financial advisory are the way to go for one-step shopping for all financial needs.

 Emerging areas of investment banks have been retail and institutional fund management, trust
services and thrift charters etc.

 The share of revenue from core investment banking has been declining steadily and is being
replaced by proprietary trading, asset management and advisory services.
 Investment banks are buying into asset management companies and also setting up private
equity to tap the available opportunity.

 The future therefore lies in ‘full service investment banking’ comprising of core investment
banking, asset management, private equity, venture capital, brokerage, S&D, research and
analysis, proprietary trading and investment, primary dealing in fixed income securities,
structured financing and corporate advisory services.

 Universal banks can add all their banking products in both corporate and retail banking
segments to the long list of services offered as full service investment banks.

 A step forward would be the financial conglomerates for the future that can even add on
insurance and pension products to make them one-stop financial shops, large financial
conglomerates such as Citygroup/ ING would be the models of growth in years to come.