The Structure of Financial Services Industry Pt. 1

The Financial Services sector is made up of many sub-sectors and smaller segments in each subsector. If you are unsure of how the Financial Services industry is structured, this blog will give you a high level overview of the main components of this industry. 

Before we begin, I want to give you a formal definition of Financial Services. According to the IMF, instead of offering goods, financial services involve transactions required to obtain financial goods. They cover a range of transactions in areas such as real estate, insurance, banking, investment funding, securities and so on. 

The way financial services are broken down is as follows.

Banking Services

The main operations of the banking sector are concerned with lending and saving, the origination of loans, redistribution of risk, creation of financial instruments and other activities. So, what does each type of bank do?

Retail banking

This branch of banking is also known as Consumer Banking, whose main function is to offer banking services to individuals. These services are savings and deposits, loans, mortgages, credit cards and so on.

Commercial banking

Similar to Retail Banking, this type of bank also offers credit services, loans, savings and deposits, and financial instruments like certificates of deposits. However, unlike Retail Banking, Commercial Banking serves businesses from small businesses to large corporations.

Investment Banking

Lastly, investment banks only deal with large corporations and high net worth individuals. This type of bank acts as an intermediary between corporations and the financial market. Their range of operations include:

  • Mergers and acquisitions
    • Also known as M&A. Mergers activity involves consolidating two separate businesses into a new single identity. Acquisition is an investment banking activity where the investment bank helps one business acquire another. For example, Elon Musk acquisition of Twitter involves the effort of multiple investment banks like Morgan Stanley, Bank of America and Barclays.
  • Underwriting / IPO
    • Initial Public Offering is the process where a private company becomes public and its stocks are traded on an exchange to institutional or individual investors. The role of the investment banks is to underwrite the process and arrange for that company stocks to be traded on exchanges. 
  • Equity research
    • This group at an investment bank does research, analysis and gives recommendations on financial investments. Banks will produce reports and papers on industry research, sector trends, valuations, forecasts, financial results and recommendations.  
  • Advisory & Restructuring
    • Advisory is responsible for helping clients identify the best opportunities for IPO, M&A or strategic partnerships and acts as advisor on these transactions. Restructuring involves strategizing and executing a reorganization of a corporation like balance sheet recapitalization or modifying the structure of a company in order to improve business performance and profitability.
  • Financing & Capital Markets
    • This division of the Investment Bank raises capital through the equity market by originating and executing convertible and equity derivatives or raises capital through the debt market by originating, structuring and selling bonds for corporate clients. In short, this team helps a corporation raise capital by either equity or debt.

Investment Services

If you ever own a brokerage account to trade stocks, you are an individual investor. There is also another type of investor called institutional investors, which are companies that make investments on behalf of other people. Now that we know investment banks are the agents who originate and sell financial instruments like stocks and bonds, the institutional investors are the ones who buy these financial instruments.

The main goal of the Investment Services sector is to make investments and manage those investments with a hope to gain profits. Their clients are other institutional investors like endowments, pension funds, foundations, and some high net worth individuals. The distinctions between individual investors and investment/asset management companies are that the latter are considered more sophisticated and skilled because they are professionally and actively managed by investment managers or portfolio managers. They only serve the range of clients listed above, and are typically not easily accessible to individual investors (except mutual funds).

There are a variety of investment management firms out there and they are categorized by either the investment strategy or the asset class that they deal with.

Hedge fund

This type of fund manages pooled capital and invests using a wide range of strategies with the goal of beating the average investment returns for their clients.  

Mutual funds

A mutual fund is a pooled financial vehicle that invests in stocks, bonds, money market instruments and so on. Each mutual fund of stocks or other assets consists of many different investments in its kind (e.g. A mutual fund of stocks has different stocks from many different companies), and therefore, gives individual/small investors access to a professionally managed portfolio and exposure to diverse investments. The objective of mutual funds is to generate gains and income previously specified by investors. 

Private Equity

If stocks are the way to invest in public companies, private equity is how  private companies get access to capital. Briefly, private equity firms are partnerships that use pooled capital from investors to buy and manage private companies before selling them. The goal is to acquire a company or buy stakes in a private company then sell it later to make a profit.

Venture Capital

Similar to private equity, venture capital also invests in private companies and manages investments in a way that will generate profit. The difference is that venture capital invests in startups and companies in earlier stages, which makes it more risky of an investment.

Aside from the banking and investment services, we also have insurance services and tax and accounting services that also make up the finance space. These sectors, however, are not divided into many types of segments and are generally straightforward, so we will only focus on the above two here.

Follow this series for more breakdowns and clarification of this dynamic space called finance !

By Thao Pham
Thao Pham Peer Career Fellow: Technology, Data and Science and Financial Services, Consulting and Business