Conflict of Interest in Investment Banking
February 12, 2025
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Investment banks perform a wide variety of activities. As we have explained in previous articles, the work performed by investment banks overlaps with the work performed by a lot of other financial institutions. Hence, they also make money in a wide variety of ways. They sell their services to large corporations and even governments.
Over the years, investment banks have been under the scanner since it is believed that they make large amounts of money and give out obscene bonuses to their top management while acting unethically. Investment banks are able to make huge sums of money since they have multiple revenue streams.
In this article, we will have a closer look at some of the revenue streams which are generated by investment banks.
Investment banks have entire departments that are dedicated to the advisory practice. Big corporations and even governments consult these banks about the best way to raise finance. They advise on which instruments can be used, which markets can be tapped, and even when the appropriate timing is to bring out a public issue.
Since the advice is provided by some of the most seasoned investment bankers, the investment banks often charge a high consulting fee, which varies with the number of hours of work that the investment banker had to put in.
Similarly, many large investment banks around the world have their own proprietary trading desks. This means that they invest their own money and not the money owned by the clients. In these cases, since they are investing their own money, they are obviously the beneficiaries of the profits that they generate from such trading. Proprietary trading banks at investment banks often look at arbitrage opportunities. They try to generate risk-free profits by using their advanced know-how while investing their money. This trading income also becomes an important source of income for these companies.
Investment banks have been making huge profits by buying assets, pooling and tranching them, and then selling them for a much higher price. However, this approach also carries some risks. For instance, during the subprime mortgage crisis of 2008, many investment banks were not able to sell the assets that they had on their books. They had held these assets temporarily only for the purpose of sale. However, due to the credit freeze, they were not able to offload the assets on time. Many investment banks came to the verge of bankruptcy because of the losses incurred as a result of these assets.
The bottom line is that investment banks have several sources of income. Hence, even if one of the sources of income dries up, it does not mean that the entire operation of the investment bank will be affected. Because of these diversified sources of income, investment banks see a stable flow of income.
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