Investment Banks & Property Dealers

You know there are always some questions which you have always wondered about but were always afraid to ask as it would make you look like a complete idiot. One of those questions which has always troubled me is - what do investment banks do?

So I tried my own process of self-education by looking up the meaning of investment banking in the dictionary.

Investment - "the investing of money or capital in order to gain profitable returns, as interest, income, or appreciation in value. "

Banking - "an institution for receiving, lending, exchanging, and safeguarding money and, in some cases, issuing notes and transacting other financial business. "

Right, so now I get it - an Investment bank is a place where I deposit my money and the bank then lends it out to others to gain profitable returns on it. But wait a minute - how is this any different from the basic concept of banking? A bank after all is a trust worthy (theoretically) institution where individuals deposit their hard earned money. The bank in turn lends out this money to businesses and individuals to gain interest incomes. A bank also plays a critical role in the economy by ensuring that the deposited money is clean. It further ensures that money is lent out to customers who meet two critical criteria -

1. The ability to pay - adequate income
2. The willingness to pay - no crooks please

By assessing these two parameters, a bank ensures clean depositors, and sound, credit worthy borrowers. At a fundamental level, it efficiently directs a country's savings into productive, credit worthy investments. The bank in turn accepts some risk on its own books (risk of a credit-worthy borrower defaulting) and generates income through interest by taking these risks. A classical, hard earned, entrepreneurial way of making money fair and square. Take a risk and make the money.

So how is an investment bank different. A recent article in the FT by a man called John Gapper finally answered all my questions. An investment bank is defined as a bank which was once run by the hard working guy but has recently appointed a smart working guy as its CEO.

An investment bank does the exact same thing as a bank, but removes the blood, sweat and tears from the process. So here is how an investment bank works (you may know this already but please read on as in my discussion, I come to property dealers as well, which is where it gets interesting), A wants to buy an asset, B wants to sell the asset. An investment bank helps arrange a meeting between A & B, informs B how much to sell the asset for and informs A how much to buy it for. If the sale takes place, it takes a percentage share from A & B and vanishes from the scene. Now suppose, the asset goes bad - In this case, A makes the loss & not the investment bank. This is because the risk of default no longer appears on its books. From actually lending out their own deposits and evaluating the credit-worthiness of borrowers and bearing the risk of default, banks today have become commission agents. Think about it. How different is an investment banking operation from that of a streetside property dealer?

However on further analysis, things arent really that embarrasing. There is a value-add which investment banks bring to the process - they help the interested parties by evaluating the true value of the asset being traded. But is this job really as exciting and enriching as regular banking where you get to see funds directed by you turn into huge factories employing thousands of people and generating income for your country. Leave that question for you. I have answered enough for today...