Challenges to Investment Banking Business

Investment banking has traditionally been a lucrative business. Investment bankers have always been in the news for the excessive amount of money that they made while the rest of the world was struggling. However, the relentless negative publicity that the industry has received in the past has changed the way it functions. Also, external circumstances such as the pandemic have resulted in negative effects on the investment banking industry.

The modern investment banking industry faces several challenges. Some of these challenges have been listed down in this article.

Scarce Capital Resources: The coronavirus pandemic has created recessions and depressions all over the world. As a result, in almost all markets, individuals, as well as companies, are not very comfortable investing their money. They would rather hold on to their money for some time rather than invest it in the short run. This has created a world where capital resources are scarce. The job of investment bankers is to allocate capital resources efficiently. If there are fewer capital resources to be allocated, then there is a reduced business for the investment bankers in general. This has become a challenge for the entire industry since they are looking at a prolonged recession.

Need to Reduce Costs: Markets all over the world have become increasingly competitive. As a result, the prices of goods and services are going lower. This is having a ripple effect on the finance industry as well.

Companies are facing shrinking margins, and hence the cost of capital is going down as well. The problem is that the investors are already afraid to invest money. In such a scenario, they expect more compensation in order to induce them to invest. However, the market is actually reducing the interest rates as well as the costs of equity. Hence, investment bankers are not able to reconcile the needs of corporations as well as the investors, which is creating a challenge for them as far as effective intermediation is concerned.

Increased Regulations: The investment banking industry was blamed for the mortgage crisis of 2008. This is the reason why heavy regulations have since been put into place. The new structured financial products which are created and sold by the finance industry are heavily scrutinized by the regulatory agencies. This creates limits on the operations of the investment banks. The number of new types of securities being created and traded by investment banks has seen a reduction post 2008.

Adhering to the regulations adds to the costs at investment banks. Separate departments have to be maintained in order to ensure that the bank is compliant with the changing regulations. This also makes the services of investment banks more expensive and hence less competitive.

Technology Disruption: The rapid advances in technology have drastically changed every industry in the world. The world of investment banking is no exception, either. Over a period of years, an entirely new industry called fintech has emerged.

The fintech industry is all about leveraging the use of financial technology in order to provide the same financial services for a lower price. For instance, modern fintech companies have shown that they can be more effective at raising capital as compared to investment banks. Their access to the best technology and modern network ensures that they are able to raise capital at a lower cost. Also, they have a wider reach as compared to traditional investment banks.

There are more examples where the use of technology has been more effective than investment banks. For instance, in the recent past, Bitcoin has been effectively used in order to raise capital from foreign sources. The transaction costs in the case of Bitcoin have been remarkably less as compared to the transaction costs related to normal cross border financing. If the investment banking industry does not imbibe the use of technology with immediate effect, it will soon be at the risk of becoming obsolete, thanks to fintech.

Difficulty in Cross-Selling: Investment banks have traditionally relied a lot on cross-selling. For instance, if a client comes in looking for mergers and acquisitions advisory, investment banks are often able to convince them to avail services such as issue management, capital structure advisory, and so on. There is no doubt about the fact that investment banks generate value for clients while doing these activities.

However, in the current scenario, corporations have limited budgets. This means that they have clearly instructed their finance departments to limit the number of services that they avail. This decreased budget is translating into decreased revenue for research and other departments in investment banks, which are heavily dependent upon cross-selling revenue. Companies are preferring to avail services from specialists instead of buying all the services from an investment bank for a bundled price.

The bottom line is that investment banking is not in its heydays anymore. Over the years, the negative publicity, as well as the number of challenges, have increased manifold.

No government wants to be seen as being sympathetic towards Wall Street. Hence, it is unlikely that the industry will receive any help from the government, either. The industry needs a transformation wherein the best practices from the previous models are merged with the best practices of modern technology.

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Investment Banking