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MGT604 - Management of Financial Institutions - Lecture Handout 28

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Role of Investment Banks

Investment banks

It helps companies and governments (or their agencies) raise money by issuing and selling securities in the capital markets (both equity and debt).

Almost all investment banks also offer strategic advisory services for mergers, acquisitions, divestiture, or other financial services for clients, such as the trading of derivatives, fixed income, and foreign exchange, commodity, and equity securities.

Trading securities for cash or securities (i.e., facilitating transactions, market-making), or the promotion of securities (i.e., underwriting, research, etc.) is referred to as "sell side."

The "buy side" constitutes the pension funds, mutual funds, hedge funds, and the investing public who consume the products and services of the sell-side in order to maximize their return on investment. Many firms have both buy and sell side components.

Organizational structure of an investment bank

The main activities and units

The primary function of an investment bank is buying and selling products both on behalf of the bank's clients and also for the bank itself. Banks undertake risk through proprietary trading, done by a special set of traders who do not interface with clients and through Principal Risk, risk undertaken by a trader after he or she buys or sells a product to a client
and does not hedge his or her total exposure. Banks seek to maximize profitability for a given amount of risk on their balance sheet.

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MGT604 - Management of Financial Institutions - Lecture Handout 18

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ROLE OF COMMERCIAL BANKS

Asset composition

Assets of banking sector, as per cent of GDP, have been on the decline. Slowdown in asset growth was also accompanied by changing share of different groups. Negative growth in the assets of foreign banks during 1998 and 1999 was the prime reason behind declining growth in overall assets of the banking sector. Share of NCBs have been decreasing since private
banks were allowed to operate in 1992. In terms of asset share, private banks are now as large as foreign banks.

Problem bank management

The central bank is the sole authority to supervise, monitor and regulate financial institutions. It is also responsible to safeguard the interest of depositors and shareholders of these institutions. Lately, SBP took actions against two private banks which became a threat to viability of the financial system in the country. These were Indus Bank and Prudential
Commercial Bank. On the basis of detailed investigations, the license of Indus Bank was cancelled on September 11, 2000. After successful negotiations, management and control of Prudential Bank handed over to Saudi-Pak group.

Outlook

Commercial banks have been going through the process of restructuring. There are efforts to reduce lending rates. The SBP has been successful in implementing its policies. Most of the banks have been able to adjust to new working environment. The proposed increase in capital base will provide further impetus to financial system in the country.
In the post September 11 era, the GoP borrowing from SBP and commercial banks is expected to come down substantially and private sector borrowing to increase. However, a temporary decline in repayment ability of borrowers may increase provisioning for the year 2001. The situation is expected to improve in year 2002. Unless efforts are made by banks to shrink spread, depositors will not be able to get return which corresponds with the rate of inflation in the country. Privatization of NCBs is expected to be delayed due to external factors. However, it is an opportunity for the banks to further clean their slate. Pakistan’s banking sector like many other developing countries had been faced with several problems and difficulties such as:
Most of the financial assets and deposits were owned by nationalized commercial banks (NCBs) which suffered from a highly bureaucratic approach, overstaffing, unprofitable branches and poor customer service.

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