Future of Investment Banking

Only when the tide goes out do you discover who's been swimming naked.

These were the famous words of Warren Buffett, regarding the downfall of economic system and investment banking. The investment banks generally deal in corporate finance and help their client companies to raise capital through equity, debt or other types of offerings. They also assist mergers and acquisitions and trade in equities or derivatives. After the world faced a major economic recession in the second half of 2008, many scholars and think tanks were skeptical about the restoration of the economy. However, as the market has its own share of ups and downs, the positive aspects and financial strength of investment banks cannot be neglected. The future of investment banking might comprise the following:

More Stringent Laws and Restrictions
After considering the Wall Street crash and the credit crisis in America, it is very much possible that the regulators and politicians will impose stringent laws and restrictions on investment banks. The laws and restrictions will be made with an intention to curtail the aggressive market strategies of these banks, as well as to come up with a better risk management scheme.

Claw-back Provisions
In order to make the volatile market of investment banking more secured from crashes caused by imprudent individual traders or groups, banks may tighten up the claw-back provisions. This provision requires those whose trades cause subsequent losses, to pay back all or part of their bonuses. However, this might result in the transition of traders from big names to less well-known boutiques, in order to avoid scrutiny.

Emphasis on Equity Derivatives and Currency trading
An equity derivative is an instrument used by investors to hedge the risks associated with taking a position in stocks. It consists of underlying assets based on equity securities and limits the losses incurred by either a short or long position in a company's shares. In order to derive more benefits, investment banks will be emphasizing more on currency trading, interest-rate products, equity derivatives and corporate restructuring.

Fewer big banks and more small boutiques
As the giant investment banks faced heavy losses, which in turn affected the government and investors, in future there will be fewer big banks and more boutiques. This will force the big shot investment banks to be careful about their position, as they will face stiff competition from small firms. In any case, the charm of investment banks is something which will not decrease in near future.

Lesser Dependence on Short-Term Funding
Considering the negative impact of the aggressive strategies of investment banks, in future, there might be lesser dependence on short-term funding and high leverage. As the investment banks are largely financed with short-term funding, a massive asset/liability mismatch is created which is difficult to manage. It is also probable that more investment banks will be pushed into the arms of banking acquirers with large and stable deposit bases. This will provide solution to the investment banks which are generally financed for the good times, not the bad ones.

Some people think that investment banks have already hit the bottom of a swimming pool, that too head-on. However, there is a possibility that this may be a case of things getting worse before they improve. After the improvement of economy, tougher regulations and stringent laws will make the small firms more influential and bring them on par with their giant counterparts. Then it will all depend on the investors and their capability to break into finance and investment banking, in the near future.