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In this video, I delve into the mechanisms behind how investment banks generate revenue!
Disclaimer: The opinions expressed in this video are solely my own and do not reflect those of my employer.
#wallstreet #finance #financecareers #banking #investmentbanking
Chapters:
00:00 Introduction
00:42 What are Investment Banks?
01:57 Mint Mobile
03:21 Sales & Trading
03:53 Asset Management
04:32 Total Revenue
04:59 Conclusion
Tags: how investment banks make money, how investment banks generate revenue, investment banking revenue, investment banking profits, how investment banks are compensated, how investment banks earn, how investment banks function, different divisions of an investment bank, investment banking roles, investment banking sectors
Script: Investment banks are elusive, powerful entities thought to control the financial landscape. While we’re aware they earn billions, how do they truly profit? In today’s video, we’ll unpack the details.
Unlike conventional banks, investment banks don’t accept deposits or extend mortgages. Instead, they profit from charging substantial fees for a range of financial services. Their operations center around three primary sectors: IB, S&T, and AM.
First, let’s discuss IB. These are the deal architects who advise CEOs on multi-billion dollar mergers, acquisitions, and IPOs. Suppose Company A is interested in acquiring Company B. They don’t simply search “how to acquire a company”; they turn to an investment bank to manage the entire process—from valuation to negotiations. The bank typically charges fees ranging from 1 to 3% of the overall deal value. For instance, during Microsoft’s $69 billion acquisition of Activision, investment banks earned over $1 billion just from that transaction. Remarkably, if the deal falls through, the banks are still compensated since their charges are based on the advisory service, not merely execution. They also profit from underwriting, where a company raises money by issuing stocks or bonds. Acting as intermediaries, the bank purchases shares at a lower price and sells them to the market for a profit. Consider an IPO valued at $5 billion—if the bank imposes a 7% underwriting charge, this amounts to $350 million in revenue solely from the stock launch!
Next, we have Sales & Trading, the pulsating core of Wall Street. Within this domain, investment banks earn revenue by facilitating trades for large investors across stocks, bonds, and derivatives. They generate income in three principal ways:
– **Market Making** – Engaging in the buying and selling of assets at slightly varied prices to capture the difference.
– **Proprietary Trading** – Utilizing the bank’s capital to take speculative positions in stocks, bonds, and currencies (although this practice was curtailed post-2008).
– **Commissions** – Charging fees to execute trades on behalf of hedge funds, pension plans, and institutions.
Prior to 2008, this segment was a major profit generator for investment banks, but the post-Volcker Rule environment necessitated a shift in focus due to restrictions on risky trading activities.
Lastly, there’s Asset Management, where investment banks oversee capital for affluent individuals, pension funds, and corporate entities. Their model involves charging a management fee that typically ranges from 0.5% to 2% of total assets under management (AUM). This fee may seem minimal, but when managing trillions, it accumulates rapidly. For example, UBS manages approximately $6 trillion in assets. Even a 1% fee results in $60 billion in annual revenue. Furthermore, banks are compensated for their advisory roles. Whether assisting in the restructuring of troubled firms or providing strategic consultations, they charge substantial retainer fees regardless of the outcomes.
In 2023, the world’s top investment banks collectively generated over $100 billion in revenue. For Goldman Sachs, their revenue distribution is as follows: Investment Banking (30%), Sales & Trading (40%), Asset Management (20%), and Other (10%). Regardless of economic conditions, investment banks find ways to ensure profitability—benefiting from IPOs in bullish markets, navigating bankruptcies during downturns, and all scenarios in between.
