MODULE_1_13_

BANKING &
INVESTMENT LAWS

CERTIFICATE COURSE

DEVELOPED BY
Corp Comm Legal

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MODULE - 1

INTRODUCTION TO INVESTMENT
BANKING

1.1. EVOLUTION OF BANKS 1.1.3. The First Bank
1.1.1. Origin of the word ‘Bank’
The Romans, great builders and administrators in
According to some authorities the word ‘Bank’ itself is their own right, took banking out of the temples and
derived from the word “bancus” meaning bench. One formalized it within distinct buildings. During this
of the early bankers, the Jews in Lombardy transacted time, moneylenders still profited, as loan sharks do
their business on benches in the market place. When a today, but most legitimate commerce, and almost all
banker failed, his bench was broken up by the people, governmental spending, involved the use of an
hence the word bankrupt. institutional bank. Julius Caesar, in one of the edicts
changing Roman law after his takeover, gives the first
1.1.2. Early History of Banking example of allowing bankers to confiscate land in lieu
of loan payments. This was a monumental shift of
As early as 2000 B.C., the Babylonians had developed power in the relationship of creditor and debtor, as
a banking system. There is evidence to show that the landed noblemen were untouchable through most of
temples of Babylon were used as banks and such great history, passing debts off to descendants until either
temples as those of Ephesus and of Delphi were the the creditor's or debtor's lineage died out. The Roman
most powerful of the Greek banking institutions. But Empire eventually crumbled, but some of its banking
the spread of irreligion soon destroyed the public institutions lived on in the form of the papal bankers
sense of security in depositing money and valuables in that emerged in the Holy Roman Empire, and with the
temples and the priests no longer acted as financial Knights Templar during the Crusades. Small-time
agents.

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moneylenders that competed with the church were 1.3. WHAT IS AN INVESTMENT BANK?
often denounced for usury.
The term ‘investment bank’ refers to a class of
1.2. MEANING OF BANKING financial institutions whose fundamental job is to help
finance long-term capital needs of business and
A bank is a financial institution and a financial governments. Typically, an investment bank
intermediary that accepts deposits and channels intermediates between the issuers of and investors in
those deposits into lending activities, either directly securities, such as stocks and bonds. Investment
or through capital markets. A bank connects banks may employ their own capital in investing or
customers that have capital deficits to customers with not.i Investment banking is a field of banking that aids
capital surpluses. Due to their critical status within the companies in acquiring funds. In addition to the
financial system and the economy generally, banks are acquisition of new funds, investment banking also
highly regulated in most countries. They are generally offers advice for a wide range of transactions a
subject to minimum capital requirements which are company might engage in.
based on an international set of capital standards,
known as the Basel Accords. An investment bank is a financial institution that
assists individuals, corporations and governments in
The Bank for International Settlements (BIS) is an raising capital by underwriting and/or acting as the
international organisation which fosters international client's agent in the issuance of securities. An
monetary and financial cooperation and serves as a investment bank may also assist companies involved
bank for central banks. The Basel Accords refer to the in mergers and acquisitions, and provide ancillary
banking supervision Accords (recommendations on services such as market making, trading of derivatives,
banking regulations)—Basel I, Basel II and Basel III— fixed income instruments, foreign exchange,
issued by the Basel Committee on Banking commodities, and equity securities.
Supervision (BCBS). They are called the Basel Accords
as the BCBS maintains its secretariat at the Bank for Investment bankers identify capital opportunities,
International Settlements (BIS) in Basel, Switzerland negotiate and structure deals, and execute private
and the committee normally meets there and public financial transactions. The essential

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function of an investment bank is to act as an give buy-and-sell advice to the companies they
intermediary between potential investors and those represent.
who seek capital. Investors include individuals, mutual
funds, municipalities, public corporations, and private Unlike commercial banks and retail banks, investment
institutions. banks do not take deposits. There are two main lines
of business in investment banking. Trading securities
An investment banking firm also does a large amount for cash or for other securities (i.e., facilitating
of consulting. Investment bankers give companies transactions, market-making), or the promotion of
advice on mergers and acquisitions, for example. They securities (i.e., underwriting, research, etc.) is the "sell
also track the market in order to give advice on when side", while dealing with pension funds, mutual funds,
to make public offerings and how best to manage the hedge funds, and the investing public (who consume
business' public assets. Some of the consultative the products and services of the sellside in order to
activities investment banking firms engage in overlap maximize their return on investment) constitutes the
with those of a private brokerage, as they will often "buy side". Many firms have buy and sell side
components.

1.4. DIFFERENCE BETWEEN COMMERCIAL BANK AND INVESTMENT BANKii

Basis Commercial Bank Investment Bank
Meaning
Commercial bank is a bank that provides Investment bank refers to a financial institution,
Risk involved
Type of clients services like accepting deposits, lending that offers services like underwriting of
Type of service
money, payment on standing order and much securities, brokerage services and so on.

more.

There is a low level of risk involved. The level of risk in the investment bank is

higher.

Commercial bank deals with the individuals. Investment bank deals with investors, big

corporations and government.

Commercial bank provides standard service Investment bank provides customer-specific

to all their customers. service according to his need.

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Customer base Commercial banks have a wide customer Investment bank has a narrow customer base.
Income base.
Commercial banks earn income from the Fees from the services provided and
fees charged and the gap in the interest rate. commission by acting as a mediator.

1.5. HISTORY OF INVESTMENT BANKING IN THE market investment, was deemed the main culprit of
WORLDiii the financial crash. According to that reasoning,
commercial banks took on too much risk with
Traditionally, banks either engaged in commercial depositors’ money.
banking or investment banking. In commercial
banking, the institution collects deposits from clients Commercial banks were accused of being too
and gives direct loans to businesses and individuals. speculative in the pre-depression era, not only
because they were investing their assets but also
The stock market crash of 1929 and ensuing Great because they were buying new issues for resale to the
Depression caused the U.S. government to reach the public. Thus, banks became greedy, taking on huge
conclusion that financial markets needed to be more risks in the hope of even bigger rewards. Banking itself
closely regulated in order to protect the financial became sloppy and objectives became blurred.
interests of average Americans. This resulted in the Unsound loans were issued to companies in which the
separation of investment banking from commercial bank had invested, and clients would be encouraged
banking. to invest in those same stocks.

The Glass–Steagall Act of 1933 introduced the In the United States, The Securities Act of 1933
separation of bank types according to their business became a blueprint for how investment banks
(commercial and investment banking). In order to underwrite securities in the public markets. The act
comply with the new regulation, most large banks split established the practices of due diligence, issuing a
into separate entities. This act separated investment preliminary and final prospectus, and pricing and
and commercial banking activities. At the time, syndicating a new issue. The 1934 Securities
"improper banking activity", or what was considered Exchange Act addressed securities exchanges and
overzealous commercial bank involvement in stock broker-dealer organizations. The 1940 Investment

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Company Act and 1940 Investment Advisors Act their status as investment banks by converting
established regulations for fiduciaries, such as mutual themselves into traditional commercial banks.
funds, private money managers and registered
investment advisors. 1.5.1. Adam Smith and Modern Bankingiv

Provisions of the Glass-Steagall Act that prohibit a Banking was already well established in the British
bank holding company from owning other financial Empire when Adam Smith came up with his "invisible
companies were repealed on November 12, 1999, by hand" theory in 1776. Moved by his views of a self-
the Gramm–Leach–Bliley Act. The repeal of the regulated economy, moneylenders and bankers
Glass–Steagall Act of 1933 effectively removed the managed to limit the state's involvement in the
separation that previously existed between Wall banking sector as well as the economy. The
Street investment banks and depository banks. The established free market capitalism and competitive
Gramm-Leach-Bliley Act allowed banking institutions banking was found fertile in the New World, where
to provide a broader range of services, including the United States of America was getting ready to
underwriting and other dealing activities. emerge.

However, the period of 2010-2011 marked the return However, initially Smith's ideas did not benefit the
of confidence in investment banking. JP Morgan, Bank American banking industry. The average life for an
of America, Merrill Lynch and Goldman Sachs were American bank was five years, after which most bank
the leading investment banks in 2010. Mergers and notes from the defaulted banks had no worth. The
Acquisitions and Private Equity funding are on the rise state-chartered banks could only issue bank notes
again and deal-activity has increased. The financial against gold and silver coins they had in reserve. A
crisis in 2007/2008, led to questioning of the business bank robbery meant a lot more before, than it does
model of the investment bank. The Investment now. These risks compounded to the cyclical cash
Banking industry began to collapse. Investment banks crunch in America.
Bear Stearns (founded in 1923) and Merrill Lynch
(1914), were acquired by commercial banks. Lehman 1.5.2. Merchant Banksv
Brothers (1850) filed for bankruptcy and Goldman
Sachs (1869) and Morgan Stanley (1935) abandoned Most of the economic duties that would have been
handled by the national banking system, in addition to
regular banking business like loans and corporate

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finance, fell into the hands of large merchant banks, had to work together on large issues, their customers
because the national banking system was so sporadic. were split along clear class and race lines. These banks
During this period of unrest that lasted until the left consumer loans to the lesser banks that were still
1920s, these merchant banks parlayed their failing at an alarming rate.
international connections into both political and
financial power. These banks included Goldman and 1.5.4. The Panic of 1907vi
Sachs, Kuhn, Loeb, and J.P. Morgan and Company.
Originally, they relied heavily on commissions The collapse in shares of a copper trust set off a panic
from foreign bond sales from Europe, with a small that had people rushing to pull their money out of
backflow of American bonds trading in Europe. This banks and investments, which caused shares to
allowed them to build up their capital. plummet. Without the Federal Reserve Bank to take
action to calm people down, the task fell to J.P.
1.5.3. Morgan and Monopoly Morgan to stop the panic, by using his considerable
clout to gather all the major players on Wall Street to
J.P. Morgan and Company emerged at the head of the maneuverer the credit and capital they controlled,
merchant banks during the late 1800s. It was just as the Fed would do today.
connected directly to London, then the financial
center of the world, and had considerable political 1.5.5. The End of an Era
clout in the United States. Morgan and Co. created
U.S. Steel, AT&T and International Harvester, as well Ironically, this show of supreme power in saving the
as duopolies and near-monopolies in the railroad and U.S. economy ensured that no private banker would
shipping industries, through the revolutionary use ever again wield that power. The fact that it took J.P.
of trusts and a disdain for the Sherman Anti-Trust Act. Morgan, a banker who was disliked by much of
America for being one of the robber barons with
Although the dawn of the 1900s had well-established Carnegie and Rockefeller, to do the job, prompted the
merchant banks, it was difficult for the average government to form the Federal Reserve Bank,
American to get loans from them. These banks didn't commonly referred to today as the Fed, in 1913.
advertise and they rarely extended credit to the Although the merchant banks influenced the
"common" people. Racism was also widespread and, structure of the Fed, they were also pushed into the
even though the Jewish and Anglo-American bankers background by it.

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Even with the establishment of the Federal Reserve, industriousness it generated, lifted the U.S. and world
financial power, and residual political power, was economies back out of the downward spiral.
concentrated in Wall Street. When World War I broke
out, America became a global lender and replaced For the banks and the Federal Reserve, the war
London as the center of the financial world by the end required financial maneuvers using billions of dollars.
of the war. Unfortunately, a Republican This massive financing operation created companies
administration put some unconventional handcuffs on with huge credit needs that, in turn, spurred banks
the banking sector. The government insisted that into mergers to meet the new needs. These huge
all debtor nations must pay back their war loans, banks spanned global markets. More importantly,
which traditionally were forgiven, especially in the domestic banking in the United States had finally
case of allies, before any American institution would settled to the point where, with the advent of deposit
extend them further credit. insurance and mortgages, an individual would have
reasonable access to credit.vii
This slowed down world trade and caused many
countries to become hostile toward American goods. 1.6. OBJECTIVES OF INVESTMENT BANKING
When the stock market crashed on Black Tuesday in
1929, the already sluggish world economy was An Investment Banker is an intermediary between the
knocked out. The Federal Reserve couldn't contain capital markets (investors) and corporations
the crash and refused to stop the depression; the (borrowers). He offers strategic 9 advice and
aftermath had immediate consequences for all banks. performs financial analysis. He also does research and
A clear line was drawn between being a bank and analyses all public information to give advice on
being an investor. In 1933, banks were no longer publicly listed stocks and bonds to investors and sales
allowed to speculate with deposits and the FDIC and trading groups.
regulations were enacted, to convince the public it
was safe to come back. No one was fooled and the The objectives of Investment Banking include:
depression continued.
▪ Guidance
1.5.6. World War II Saves the Day ▪ Project Formulations
▪ Implementation
World War II may have saved the banking industry ▪ Modernization
from complete destruction. WWII, and the ▪ Diversification

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▪ Mobilizing resources ▪ Investment banking provides financial advice
▪ Raising Capital to investors and helps them by assisting in
purchasing and trading securities as well as
Investment banks work for companies and managing financial assets
governments, and profit from them by raising money
through the issuance and selling of securities in capital ▪ Investment banking differs from commercial
markets and insuring bonds, and providing the banking as investment banks don't accept
necessary advice on transactions such as mergers and deposits neither do they grant retail loans
acquisitions. Most of investment banks provide
strategic advisory services for mergers, acquisitions, ▪ Small firms which provide services of
divestiture or other financial services for clients, like investment banking are called boutiques. They
the trading of derivatives, commodity, fixed income, mainly specialize in bond trading, providing
foreign exchange, and equity securities. technical analysis or program trading as well
as advising for mergers and acquisitionsviii
An Investment Banker can be considered as a total
solutions provider for any corporate, desirous of 1.7. ROLE OF AN INVESTMENT BANKix
mobilizing its capital. The services provided range
from investment research to investor service on the The sale of stocks and bonds is one of the primary
one hand and from preparation of the offer ways for a company to raise capital. But executing
documents to legal compliances & post issue these transactions requires special expertise, from
monitoring on the other. pricing financial instruments in a way that will
maximize revenue to navigating regulatory
Investment banks carry out multilateral functions. requirements. That’s where an investment
Some of the important points regarding functioning of bank usually comes into the picture.
investment banking are as follows:
In essence, investment banks are a bridge between
▪ Investment banking helps public and private large enterprises and the investor. Their main roles
corporations in issuance of securities in the are to advise businesses and governments on how to
primary market. They also act as meet their financial challenges and to help them
intermediaries in trading for clients. procure financing, whether it be from stock offerings,
bond issues or derivative products.

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1.7.1. Advisor 1.7.2. Underwriting stocks and bonds

Deciding how to raise capital is a major decision for If an entity decides to raise funds through an equity or
any company or government. In most cases, they lean debt offering, one or more investment banks will also
on an investment bank – either a large Wall underwrite the securities. This means the institution
Street firm or a “boutique” banker – for guidance. buys a certain number of shares – or bonds – at a
predetermined price and re-sells them through an
Taking into account the current investing climate, the exchange.
bank will recommend the best way to raise funds. This
could entail selling an ownership stake in the company Suppose Acme Water Filter Company hopes to obtain
through a stock offer or borrowing from the public $1 million in an initial public offering. Based on a
through a bond issue. The investment firm can also variety of factors, including the firm’s expected
help determine how to price these instruments by earnings over the next few years, Federici Investment
utilizing sophisticated financial models. Bankers determines that investors will be willing to
pay $11 each for 100,000 shares of the company’s
In the case of a stock offering, its financial analysts will stock. As the sole underwriter of the issue, Federici
look at a variety of different factors – such as earnings buys all the shares at $10 apiece from Acme. If it
potential and the strength of the management team – manages to sell all 100,000 at $11, the bank makes a
to estimate how much a share of the company is nice $100,000 profit (100,000 shares x $1 spread).
worth. If the client is offering bonds, the bank will look
at prevailing interest rates for similarly rated However, depending on its arrangement with
businesses to figure out how much it will have to the issuer, Federici may be on the hook if the public’s
compensate borrowers. appetite is weaker than expected. If it has to lower the
price to an average of $9 a share
Investment banks also offer advice in a merger or to liquidate its holdings, it’s lost $100,000. Therefore,
acquisition scenario. For example, if a business is pricing securities can be tricky. Investment banks
looking to purchase a competitor, the bank can advise generally have to outbid other institutions who also
its management team on how much the company is want to handle the transaction on behalf of the issuer.
worth and how to structure the deal in a way that’s But if their spread isn’t big enough, they won’t be able
favorable to the buyer. to squeeze a healthy return out of the sale.

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In reality, the task of underwriting securities often use these reports internally but can also
falls on more than one bank. If it’s a larger offering, the generate revenue by selling them to hedge
managing underwriter will often form a syndicate of funds and mutual fund managers.
other banks that sell a portion of the shares. This way,
the firms can market the stocks and bonds to a larger ▪ Trading and Sales – Most major firms have a
segment of the public and lower their risk. The trading department that can execute stock
manager makes part of the profit, even if another and bond transactions on behalf of their
syndicate member actually sells the security. clients. (L8) In the past, some banks have also
engaged in proprietary trading, where they
Investment banks perform a less glamorous role in essentially gamble their own money on
stock offerings as well. It’s their job to create the securities; however, a recent regulation
documentation that must go to the Securities and known as the Volcker Rule has clamped down
Exchange Commission before the company can sell on these activities.
shares. This means compiling financial statements,
information about the company’s management and ▪ Asset Management – The likes of J.P.
current ownership and a statement of how the firm
plans to use the proceeds. Morgan and Goldman Sachs manage huge

1.7.3. Other activities portfolios for pension funds, foundations and

While advising companies and helping them raise insurance companies through their asset
money is an important part of what Wall Street firms
do, most perform a number of other functions as well. management department. Their experts help
In fact, most major banks are highly diversified in
terms of the services they offer. Some of their other select the right mix of stocks, debt
income sources include:
instruments, real estate trusts and
▪ Research – Larger investment banks have
large teams that gather information about other investment vehicles to achieve their
companies and offer recommendations on
whether to buy or sell their stock. They may clients’ unique goals.

▪ Wealth Management – Some of the same
banks that perform investment
banking functions for Fortune 500 businesses
also cater to everyday investors. Through a
team of financial advisors, they help

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individuals and families save for retirement opportunities to “securitize” income streams,
and other long-term needs. assemble the assets and market them
to institutional investors.
▪ Securitized Products – These days, companies
“In fact, the term “investment bank” is something of a
often pool financial assets – misnomer. In many cases, helping companies raise
capital is just one part of a much bigger operation”x
from mortgages to credit card receivables –

and sell them off to investors as a fixed-income

products. An investment bank will recommend

i vi Ibid.
vii Supra note 4.
http://economics.emory.edu/home/documents/workingpapers/f
ohlin_14_16_paper.pdf viii
ii https://www.bankexamstoday.com/2017/10/difference-
between-commercial-and.html http://www.caaa.in/Image/Overview%20of%20Investment%2
0Banking.pdf
iii
ix
www.caaa.in/Image/Overview%20of%20Investment%20Bank
ing.pdf https://www.investopedia.com/articles/investing/111114/what
s-role-investment-bank.asp
iv https://www.investopedia.com/articles/07/banking.asp x Tanmay Datta, The Role of Investment Banking
v Ibid. <http://www.academia.edu/23702075/Role_of_Investment_Ba
nk_Final >

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