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This series aims to provide an overview of investment banks' key operations, and in the course of doing so highlight some of the ills of organisations that even their regulator Lord Turner said were no longer 'socially useful'.

I'll have worked in a major investment bank for 6 years. And like almost every other new recruit I had only the vaguest notion of exactly what investment banks do. This didn't raise any particular concerns about whether or not this inherent complexity was a good thing at the time I was too concerned about whether or not I was going to be able to cope in a super-competitive environment and the consequences for my career should anyone find out how little I grasped. Having now participated as an assessor at a number of graduate recruitment sessions I'm happy to report that my experience is shared with nearly every new employee who secures a role in an investment bank for the first time.

This complexity marks out investment banking from nearly every other industry sector I can think of: the products and services offered are esoteric to say the least, and there are a plethora of them available. This complexity is it seems never ending, and no banker I've met would disagree the statement: it would be impossible for one person to understand all elements of investment banking. I know what you're thinking... Isn't a bank somewhere that either lends money or takes deposits? How hard can it be? And in essence this is true for what are called retail and commercial banks (we'll get into this in a later post), sadly not so for investment banks. Investment banks, thanks in no small part to the complexity of the rules that govern the system (usually referred to by investment bankers as 'the markets') they operate within.

Complex systems have a nearly infinite number of permutations, and 'the markets' are certainly complex. For example think about how many different equations you could devise if you were only able to use addition and numbers between 1 and 10 as opposed to addition, subtraction, multiplication and division and numbers from 0 to infinity. Clearly you'd be able to devise far many more equations with the later, many of which would be much more difficult to interpret. This example is a little cumbersome and not entirely analogous, but what it highlights is:

1. Complex systems (read: algebra / 'the market') yield opportunities to develop an almost infinite number of statements (read: equations / products); and
2. The complexity of these statements make interpretation nearly impossible to understand for all but the experts.

This complexity means that investment banks customers are confronted with a perilous situation. How are they to know whether or not a particular product is what they need? The complexity of the product(s) offered means the customer often will be unable to determine whether or not they stand to benefit from the product on offer. So how on earth are they to figure out what to do? Simple answer, ask an investment bank! And here we've stumbled across our very first issue. How can someone who is charged with both selling a product or service, simultaneously offer impartial advice? I would contend they cannot, yet these types of conflicts are commonplace.

This complexity not only presents opportunities for exploitation, it makes the task of understanding investment banks difficult. This difficulty plays into the hands of the bankers in another way... In life when we're confronted with something complex or unknown that we do not understand we take our opinions from the experts. This is always a rather more precarious approach than building our own view from the ground up, but we can improve the outcomes of this approach by applying some common sense. For example if I wanted to find out which new CD I might like to buy I could talk with friends with similar taste or read reviews by a reviewer I've found expresses opinions that align with my own.

Unfortunately the only pool of experts available to help us form our views on investment banking are a little more restricted, as this is effectively composed of investment bankers, and not even all of them qualify. And just as the artist who recorded the CD is unlikely to provide anything less than a glowing review, investment bankers are similarly inclined to extol the virtues of investment banks. Clearly this situation won't do.

Tagged under: Austerity