11:51 am - Tuesday March 28, 2017

Investment banking and revenue pressures – ways to go

Setting: One of the purposes of any business is to make money. And banking is no exception to this cardinal objective of any business.

Normally the bank’s income portfolio comprises fund based income and fee based income.

Fund based income is also called interest income and banks generate this by accepting deposits and lending loans at different interest rates (we need to highlight here, the interest rates on deposits will be lower than the interest rates on loans)

The fee generating activities can be broadly grouped under traditional, new production and non-traditional methods.

Traditional Fee generating activities are deposit account services provided by the banks by way of safekeeping, checking, etc, non fund based activities like issuance of letters of credit, letters of guarantee, etc and trust accounts in the form of wealth management.

The new production methods include deposit account services like on line bill pay, lending in the form of securitization and cash management.

The non-traditional fee generating activities comprise investment banking, securities brokerage and merchant banking.

Of all these traditional, new production methods and non-traditional fee based activities, investment banking attracted much flak in the recent global financial markets melt down.

Investment banking: Before we proceed further to analyze the main theme, let us demystify investment banking.

The very basic definition of investment banking is trading in various asset classes like commodities, equities, fixed income, foreign exchange and derivatives.

Investment banking work is normally categorized into three segments – Front Office, Middle Office and Back Office.

The Front Office activities are further broken into Sales, Trading, Research and Structuring.

Sales job is to call on institutional and HNI investors to suggest trading ideas and take orders. Sales desk then communicate clients’ orders to trading desks. They price and execute trades. They also facilitate structure new products that fit a specific need.

Trading is the most profitable area for our modern banks. It is responsible for majority of revenue. In the process of market making, traders buy and sell financial products. Golden rule followed by a trader is “Buy Low and Sell High”. The goal of a trader is to make an incremental amount of money on each trade.

Research wing reviews companies and writes reports; they do not generate revenue per se. But its resources are used to assist traders and sales force in suggesting ideas to customers. In recent years this relationship has become highly regulated.

Structuring is relatively a recent division. As derivatives have come into play, highly technical and analytical employees work on creating complex structured products which typically offer much higher margins and return than the underlying cash securities.

The middle office manages risk management; it analyses the risk traders are taking on to the balance sheet in conducting their daily trades. The risk management piece involves setting limits on the amount of capital that they are able to trade in order to prevent bad trades having a detrimental effect to a desk overall.

The back office is the real back bone of investment banking. Its operations involve data checking of trades that have been conducted, ensuring that they are not erroneous, and transacting the required transfers.

Front office requires highest caliber employees in terms of intellectual capital and inter-personal skills. Back office involves most monotonous work.

You must have by now judged correctly, front office offers great pay (with hefty bonuses, which regulators are targeting nowadays!) and back office provides comparatively great job security (with relatively low pay!)

Facilitators: The key to this lies in the various activities that have been discussed in the front, middle and back offices of investment banking.

If we can facilitate these activities, automatically the banks can be facilitated to make more money.

These facilitators can be broadly listed as skill specific, customer specific, marketing and planning.

The skill specific facilitators include ability to quote competitive price, the quote speed, the best in class settlement processes and liquidity management.

The customer specific facilitators include the ability to select best customers, offer flexible any time any where transaction facility, matured relationship with strategy advice and guidance.

Marketing will include research and development, product breadth, currency breadth, finovation and service at door steps.

Planning will include induction of appropriate technology to manage risk, development of markets, products and services on a dynamic basis, 24×7 support desks and integration with other markets.

Mantra for money making: Thus our simple mantra could be:

  • Close the gap with other global markets
  • More end points and trading venues
  • Facilitate right technology decisions
  • Connectivity choices
  • Lower latency
  • Execution speed
  • High bandwidth capabilities
  • Flexibility
  • Easier last mile access
  • Faster data feeds
  • Automated and algorithmic trading
  • Higher messaging rates
  • Throughput optimization
  • Stable global infrastructure

With a view to provide access to continuous stream of global market data, messaging, news, history and analysis to ensure successful execution of trading strategies

Of course our discussion would not be complete if we fail to uncover the present dilemma – quick connect with clients and brokers, receive orders over financial extranets, instant post or match orders, respond in shortest time (I leave it to you to decide whether milliseconds, microseconds, nanoseconds, picoseconds, femtoseconds, attoseconds, zeptoseconds and yoctoseconds!)

“Banks will make more money, for sure”

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