Investment Banking: Meaning, Functions and How it Works

Investment banking plays a crucial role in the financial world, helping businesses, governments, and other institutions raise capital and manage financial transactions. In this article, we will explore what is investment banking, its key functions, how it works, and how it differs from commercial banking.

What is Investment Banking?

Let's start with the basics - investment banking refers to a specific segment of banking operations that helps corporations, and governments raise capital and provides financial consultancy services. Unlike commercial banks, investment banks do not take deposits. Instead, they act as intermediaries between investors and companies seeking funds.

Investment banking is a service that helps companies and organizations raise money and make big financial decisions.

Here's what investment bankers do in simpler terms:

1. They help companies get money by selling shares of ownership (stocks) or by borrowing money (bonds) from investors. (Launching IPOs and Issuing Bonds)

2. They guide companies through buying other companies or joining together with them. (Mergers & Acquisitions)

3. They provide advice when companies need to reorganize their finances, especially during tough times. (Financial restructuring)

Think of investment bankers as middlemen who connect businesses that need money with people who have money to invest, while also offering expert advice on major financial decisions.

Key Functions of Investment Banks

So this is what investment banks do:

• Underwriting and Capital Raising: Investment banks help companies raise capital by guaranteeing the sale of stocks and bonds. They act as intermediaries between the issuers and investors, ensuring that funds are raised efficiently.

• Advisory Services: They provide strategic advice on mergers, acquisitions, and other financial transactions. Investment banks analyse deals and help clients make informed decisions.

• Sales and Trading: Investment banks buy and sell securities, facilitating trading for clients and providing liquidity to markets.

• Asset Management: Some investment banks offer asset management services, helping institutional and individual clients grow their investments.

• Research: They provide in-depth research on markets, industries, and companies, offering insights that help investors make sound decisions.

• Risk Management: Investment banks help clients manage financial risks through derivatives and other instruments.

These functions highlight the importance of investment banks in maintaining the stability and efficiency of financial markets.

How do Investment Banks Work?

Understanding how investment banks work involves looking at the processes they follow to provide their services:

1. Raising Capital: When a company wants to expand or start a new project, it may need funds. Investment banks help by issuing stocks or bonds to investors. They either buy these securities and sell them to the public (underwriting) or sell them on behalf of the company (best-efforts basis).

2. Mergers and Acquisitions (M&A): Investment banks guide companies through M&A deals. They help determine the value of the target company, negotiate terms, and ensure regulatory compliance.

3. Market Making: Investment banks facilitate trading by acting as market makers. This means they are ready to buy and sell securities at publicly quoted prices, ensuring liquidity.

4. Trading and Brokerage Services: They help clients trade various securities like stocks, bonds, and derivatives.

5. Advisory and Restructuring: Investment banks advise clients on restructuring operations to improve profitability or manage debt.

In short, investment banks play a critical role in connecting capital providers with capital seekers.

An investment banking (IB) company is a financial institution that helps businesses, governments, and other entities raise capital, execute mergers and acquisitions (M&A), and provide strategic financial advice. Unlike commercial banks that take deposits and provide loans, investment banks focus on high-level financial transactions.

How Investment Banks Work

Investment banks serve as intermediaries between companies (or governments) that need capital and investors who have money to invest. Their core functions include:

1. Capital Raising – Helping companies issue stocks (equity) or bonds (debt) to raise money.

2. Mergers & Acquisitions (M&A) – Advising clients on buying, selling, or merging with other businesses.

3. Trading & Market-Making – Facilitating the buying and selling of securities.

4. Advisory Services – Providing financial strategy, risk management, and restructuring advice.

Buy Side vs. Sell Side in Investment Banking

Investment banking activities are generally divided into buy-side and sell-side operations.

Sell-Side

The sell side of an investment bank focuses on helping companies raise capital, advising on transactions, and trading securities. It includes:

• Equity & Debt Issuance – Underwriting Initial Public Offerings (IPOs), secondary stock offerings, or bond sales.

• M&A Advisory (Seller Representation) – Helping a company sell its assets or business.

• Market Making & Trading – Buying and selling stocks, bonds, and other assets for institutional and retail investors.

• Equity & Credit Research – Providing research reports on companies and industries to support trading and investment decisions.

Buy Side

The buy side consists of institutional investors who use investment bank research and services to make investment decisions. This includes:

• Private Equity & Venture Capital – Investing in private companies and startups.

• Hedge Funds – Engaging in complex trading strategies for high returns.

• Asset & Wealth Management – Managing portfolios for individuals, pension funds, and institutions.

• Institutional Investors – Pension funds, mutual funds, and insurance companies making large-scale investments.

How do They Interact?

• The sell-side creates financial products and services that the buy-side consumes.

• Investment banks advise clients on acquisitions (buy-side M&A) and sales (sell-side M&A).

• Research teams on the sell side produce reports that buy-side firms use to make informed decisions.

Here are some real-life examples that show the working of Investment Banks  covering the three main functions in detail

1. Capital Raising (IPO) – Zomato’s IPO (2021)

• Investment Banks Involved: Kotak Mahindra Capital, Morgan Stanley, Credit Suisse

• Details

  • Zomato, India’s food delivery giant, wanted to raise capital through an Initial Public Offering (IPO).

  • Investment banks acted as underwriters, helping determine the IPO price, manage regulatory filings, and market the shares to institutional investors.

  • The IPO raised ₹9,375 crore ($1.3 billion), making it one of India’s biggest tech IPOs.

2. Mergers & Acquisitions (M&A) – HDFC Ltd & HDFC Bank Merger (2023)

• Investment Banks Involved: Citi, Morgan Stanley, JP Morgan

• Details

  • HDFC Ltd (India’s biggest mortgage lender) merged with HDFC Bank (India’s largest private bank) in a $40 billion deal—the largest in Indian banking history.

  • Sell-side advisors helped HDFC Ltd structure the deal and negotiate with potential buyers.

  • Buy-side advisors guided HDFC Bank on valuation, financial synergy, and regulatory approvals.

3. Debt Issuance – Reliance Industries’ Bond Issue (2022)

• Investment Banks Involved: Barclays, BofA, HSBC JP Morgan

• Details

  • Reliance Industries needed $4 billion in funding for expansion.

  • Investment banks helped issue bonds in global markets, attracting investors by structuring the deal with competitive interest rates.

  • The issuance became India’s largest-ever foreign currency bond sale, showing strong investor confidence.

Investment Banking vs Commercial Banking

While both investment and commercial banks are essential to the economy, they serve different purposes. Let's explore investment banking vs. commercial banking:

Primary Function: Commercial banks accept deposits and provide loans to individuals and businesses. In contrast, investment banks help raise capital, provide financial advisory services, and facilitate trading and investments.

Risk Level: Investment banks typically engage in higher-risk activities like trading and underwriting, while commercial banks deal with activities like lending and deposit-taking with individuals and businesses.

Clients: Commercial banks serve the general public, while investment banks cater to corporations, governments, and high-net-worth individuals.

Revenue Generation: Commercial banks earn money through interest on loans and fees. Investment banks generate profits from advisory fees, underwriting services, trading profits, and asset management fees.

Understanding these differences is essential for recognising how each type of bank supports the broader financial ecosystem.

How do Investment Banks Generate Profits?

How investment banks generate profits is a question that often arises. Here are the main ways:

• Underwriting Fees: Investment banks charge fees for underwriting securities. The riskier the underwriting, the higher the fees.

• Advisory Fees: When advising on mergers, acquisitions, or restructuring, investment banks earn significant advisory fees.

• Trading Profits: Investment banks trade securities on behalf of clients and for their accounts. Profits from these trades contribute to revenue.

• Asset Management Fees: By managing client investments, investment banks earn management and performance fees.

• Interest Income: Some investment banks earn interest on loans provided to clients, especially during leveraged buyouts.

These profit-generating activities allow investment banks to sustain their operations while offering valuable services.

Investment banking is a vital part of the global financial system. From raising capital and offering strategic advice to facilitating trading and managing assets, investment banks perform a wide range of functions. Understanding how they operate, how they differ from commercial banks, and how they generate profits gives a clearer picture of their importance in today’s economy.