INVESTMENT BANKS' ROLE REMAINS MURKY

Serious players are redefining their strategies and building up their human resource capabilities to play their role proactively

SHABBIR H. KAZMI, Special Correspondent
July 31 - Aug 06, 2006

The role of investment banks in Pakistan has remained quite murky. The proliferation of universal banking model in the country has created further ambiguity because of the niche market in which investment banks can operate. According to financial sector experts, the corporates will always require investment banks to provide a variety of services such as investment advisory, corporate restructuring, distressed assets acquisition and disposal, mergers and acquisitions, equity and debt financing.

These experts are also of the opinion that the investment banks have to get away from their aspiration to mimic commercial banks and build up their capabilities in the areas, which are begging for help. Commercial banks will never be able to compete with them either on costs or customer satisfaction even if they profess that they can provide total banking solutions to all the clients. Lately, several investment banks have merged into commercial banks but those who are serious players in this field are redefining their strategies and building up their human resource capabilities to play their role proactively.

Ideally, the activities of an investment bank should include: 1) Corporate Finance, 2) Mergers and Acquisitions (M&A), 3) Portfolio Management, 4) Syndication, 5) Trading in equities and debt instruments and 6) Research. The functions and a lot many other activities, which investment banks can undertake, can be discussed in detail. However, only an attempt can be made to briefly touch upon some of the activities in this article which an investment bank can undertake and ensure dividend payout to its shareholders.

The bread and butter of a traditional investment bank, corporate finance, generally performs two different functions: 1) Mergers and acquisitions advisory and 2) Underwriting. On the mergers and acquisitions (M&A) advising side of corporate finance, bankers assist in negotiating and structuring a merger between two companies. If a strategic investor whishes to acquire business of another entity, an investment bank can help finalize the purchase price, structure the deal, and generally ensure a smooth transaction. The underwriting function within corporate finance involves shepherding the process of raising capital for a company. Capital can be raised by selling shares as well as debt instruments.

Dealing in equities and debt instruments is another core activity of an investment bank. This activity can be undertaken as 1) classic retail broker, 2) institutional transactions and 3) the private client service. Retail brokerage develops relationships with individual investors and caters to their needs. Institutional salespeople develop business relationships with large institutional investors. Institutional investors are those who manage pension funds, mutual funds, or large corporations. Private client service representatives provide services to large net worth clients.

Traders play a vital role in the investment bank. A trader plays two distinct roles: 1) providing liquidity to the firm's clients, which is also called market making. Traders performing this function make money for the firm by selling securities at a slightly higher price than they pay for them. This price differential is known as the bid-ask spread. 2) In addition to providing liquidity and executing traders for the firm's customers, traders also may take their own trading positions on behalf of the firm, using the firm's capital hoping to benefit from the rise or fall in the price of securities. This is called proprietary trading. Typically, the market-making function and the proprietary trading function are performed by the same trader for any given security.

Research analysts follow stocks and bonds and make recommendations on whether to buy, sell, or hold those securities. They also forecast companies' future earnings. Stock analysts (known as equity analysts) typically focus on one industry and cover a limited number of stocks. Research analysts also work on the fixed income side and will cover a particular segment, particularly industry's high yield bonds. Salespeople utilize research to convince their clients to buy or sell securities through their firm. Corporate finance bankers rely on research analysts to be experts in the industry in which they are working. Reputable research analysts can generate substantial corporate finance business for their firm as well as substantial trading activity, and thus are an integral part of any investment bank.

The hub of the investment banking is the syndicate group providing a vital link between salespeople and corporate finance. Syndicate exists to facilitate the placing of securities in a public offering, a knock-down drag-out affair between and among buyers of offerings and the investment banks managing the process.

OUTLOOK

The future of investment banking in Pakistan is directly dependent on the pace of economic activities in the country as well as performance of capital market. As stated earlier a number of investments have preferred to merge with commercial banks, because they had common ownership. One of the reasons for their dismal performance was that the number of investments increased in nineties but subsequent persistent bearish sentiments led to posting of huge losses. Another important factor was that most of these banks invested heavily in equities. Poor economic fundamentals, leading to marginal profit or huge losses resulted in crash of prices of shares. With the revival of economic activities in the country brightening prospects for flotation of new companies and mergers and acquisitions investment banks in Pakistan have a lot to capitalize. However, limited availability of experts often becomes serious impediment, resulting in poor earnings for the investment banks.

KEY PERFORMANCE INDICATORS
Percent

INDICATOR

2003

2004

2005

Mar-06

NPFs to total financing

0.7

0.9

1.0

0.9

Net NPFs to net financing

-

0.2

0.2

0.1

Provision to NPFs

100.0

82.3

80.6

86.3

Net Markup Income to total assets

1.7

1.4

2.3

3.2

Non Markup Income to total assets

2.2

1.4

1.7

1.4

Operating Expense to Gross Income

54.6

65.3

49.9

46.5

ROA (average assets)

2.2

1.2

1.7

2.0

Growth in Assets

84.5

241.8

62.0

10.9

Growth in Deposits

64.6

259.5

65.4

7.5

Growth in Financing

147.0

218.2

66.3

6.4

 


 

INCOME STATEMENT
(Million rupees)

.

2003

2004

2005

Mar-06

Markup Income

406.4

1,081.0

3,164.3

1,358.9

Markup Expense

188.5

483.7

1,542.3

728.5

Net Markup Income

217.9

597.2

1,622.0

630.4

Provision Expense

(15.8)

36.0

175.6

27.8

Non Markup Income

287.4

596.0

,206.6

276.2

Operating Expense

276.0

779.0

,410.5

421.4

Profit Before Tax

245.0

378.2

,242.6

457.3

Tax

27.0

36.2

265.2

88.8

Profit After Tax

218.0

342.0

977.4

368.6

 


 

SOURCES AND USES OF FUNDS
(Million rupees)

.

2003

2004

2005

Mar-06

SOURCES:

Deposits

8,397.1

30,184.8

49,931.8

53,667.0

Borrowings

1,899.0

6,559.1

9,005.8

8,948.2

Capital & other funds

1,993.7

5,123.1

7,811.0

10,268.9

Other liabilities

624.8

2,276.1

4,744.8

6,416.9

.

12,914.6

44,143.0

71,493.4

79,301.1

USES:

Financing

8,652.2

27,535.5

45,786.2

48,717.6

Investments

1,242.3

2,007.0

1,854.2

6,034.8

Cash, bank balance, placements

1,978.5

11,899.7

19,314.3

19,718.7

Other assets

1,041.7

2,700.8

4,538.7

4,829.9

.

12,914.6

44,143.0

71,493.4

79,301.1

 


 

MODES OF FINANCING IN ISLAMIC BANKING MARCH’2006

Musharaka

0.60%

Ijarah

30.30%

Murabaha

51.40%

Diminishing Musharaka

13.00%

Istisna/Qarz/Qarz-e-Hasna

0.00%

Salam

0.90%

Others

3.90%

 


 

INVESTOR DISTRIBUTION

Govt. Agencies

25%

Asset Managers

23%

Banks (Islamic)

19%

Banks & Trusts

19%

Corporations

2%

Bank (Private)

11%

Insurance Companies

1%

Source* SBP