2008 saw a seismic shift in the banking industry in the U.S. On September 22, 2008, the last two major independent investment banks on Wall Street, Goldman Sachs and Morgan Stanley, elected to become full-function banking institutions (that is, offering both investment banking and commercial banking functions). This was in response to the financial crisis at that time. Around the same time, other Wall Street investment banks were either broken up (Lehman Brothers, for example) or purchased by full-function banks (Merrill Lynch and Bear Stearns, for example). This is the largest shift in the banking scene since the great depression.
The absorption or demise of these large Wall Street investment banks, the so-called “bulge bracket” companies, leaves a vacuum in the financial world. The subject of this paper is a new form of investment banking emerging to fill that vacuum.
Both on Wall Street and throughout the U.S., a new form of investment banking is emerging. It is led by banking executives who have hopefully learned from the financial crisis of 2008. More accurately, we can say that an old form of investment banking is re-emerging. The new form of investment banking emerging is actually a return to the roots of investment banking and represents a healthy trend. This brief paper describes this new/old form of investment banking and why it is re-appearing.
A little background will be helpful. Originally what is known as investment banking in the U.S. was known as “merchant banking” when it began in Europe. Going way back to the beginning of the renaissance in Europe, merchant banks originally provided a range of financial services to farmers and grain dealers. These services included loaning money to farmers collateralized by the grain in the field and insuring the grain crops against bad weather. Bankers would also advance money to farmers and dealers while grain was in shipment to a foreign port. These types of services were gradually made available to other types of businesses. It was all about helping businesses and merchants and making a fair profit in the process.
Later on, merchant banks were allowed to sell their clients’ loans (in the form of bonds) and their clients’ stock certificates to the investing public. Thus began the practice of “underwriting” in which the merchant bank first buys an issuing company’s bonds or stock and then resells it to the investing public. Throughout all this time, the primary function of the merchant bank remained the same – to assist businesses with their financing needs. The merchant bank would profit to the degree that their business clients survived and grew.
Skipping hundreds of years of gradual evolution, this brings us to the present day. There are three main missions of an investment bank. First, the primary mission remains to assist businesses in obtaining financing. Second, there are other related services for businesses such as assisting with mergers, acquisitions and divestitures. All these services involve in some way the providing of financing and financing-related advice to businesses. Third, investment banks also have to attract investors who have money to invest (i.e., who want to buy stocks and bonds). So the third primary mission of an investment bank is to assist investors in investing their spare assets profitably and safely. In summary, investment banks have both a sell side (helping businesses find investors) and a buy side (helping investors to find business opportunities in which to invest).
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