Have you ever heard about Investment Banks? What is the Difference between commercial banks & investment banks? Why do we need different kinds of banks? What are the functions of these banks? These are some questions which pop up in our mind when we think about the trends in modern banking systems.
In this article we are discussing about Commercial Banking and Investment banking. We have received so many queries regarding Investment banking; here we are trying to clarify all those queries.
What are commercial banks? Commercial banks are those we generally call as “Banks.” Commercial banks can provide loans to individuals and small businesses. Simultaneously it raises funds by collecting deposits from the same groups of people. Interest charged on loans is one of the major sources of its income. It also purchases bonds from governments and corporate entities.
In other words Commercial bank is an institution which accepts deposits, lends loans, and offers related services. Commercial banks also offer a variety of deposit accounts, such as savings, Recurring, and Fixed/Term deposit. These institutions are run to make a profit. While commercial banks offer services to individuals, they are also concerned with receiving deposits and lending to businesses.
Functions of Commercial Banks
- Accepting deposits
- Lending of credit
- Collection of cheques, demand drafts (DD), promissory notes, bills of exchange, etc.
- Purchase of domestic and foreign currency documentary, negotiation of bills under domestic and foreign letters of credit, advising of domestic and foreign letters of credit established by branches and correspondents.
- Giving standing instructions for payments
- Issue of performance guarantees and financial guarantees
- Safe custody of securities and deeds
- Purchasing and selling of securities
- Fund remittance
- Collection of bills, interest on securities, dividend on shares
- Credit transferring
- Issuance of travelers’ cheques and gift cheques
- Acting as trustees and executors
- Issue of credit cards
- Underwriting of shares
An investment bank is an institution that executes a variety of financial services for individuals, corporations, and the government. The basic function of an investment bank is to raise capital for budding companies and the government by issuing equity and debt securities. Fundamentally, the role of an investment bank is to operate as an agent between companies and the public markets in need of funding.
The main difference between an investment bank and commercial bank is that an investment bank does not accept deposits or lend credit. An investment bank also offers advisory and strategic services related to mergers, acquisitions, and corporate restructuring. A typical investment bank may offer risk management and broker dealer services as well investment bank is also known as an underwriter.
Investment banks raise funds for businesses and government by registering and issuing debt or equity and selling it in the market. Traditionally, investment banks only participated in underwriting and selling securities in large chunks. Investment banks also facilitate mergers and acquisitions through share sales and provide research and financial consulting to companies.
Activities of Investment Banks
While large full-service investment banks offer all lines of businesses (both sell side and buy side), smaller sell side investment firms and small broker-dealers are focusing on sales/trading/research, respectively.
Investment banks offer services to both corporations & investors. They help corporations in issuing securities and investors in buying securities. For corporations they offer information on when and how to place their securities in the market. For the investor, they offer protection against unsafe securities. The offering of a few bad issues can cause serious loss to its status, and therefore loss of business. Hence, investment bankers play a crucial role in issuing new security offerings.
Functions of Investment Banks
Following are the major functions of investment banks;
- Corporate Finance
Corporate finance is the bread and butter of a traditional investment bank, corporate finance generally performs two different functions such as:
1. Mergers and acquisitions advisory and
On the mergers and acquisitions (M&A) advising side of corporate finance, bankers assist in negotiating and structuring a merger between two companies. For instance, a company wants to buy another company, in this case an investment bank will help in finalizing the purchase price, structure, deal, and generally ensure a smooth transaction. The underwriting task within corporate finance involves sharpening the process of raising capital for a company. In the world of investment banking, capital can be raised by selling either stocks or bonds to investors.
Sale is another crucial aspect of any investment bank. Salespeople take the form of;
1. Classic retail broker
2. Institutional salesperson
3. Private client service representative.
Brokers build up relationships with individual investors and sell stocks and stock advice to them. Institutional salespeople expand business relationships with large institutional investors. Institutional investors are those who deal with large groups of assets, for instance pension funds or mutual funds. Private Client Service (PCS) representatives comes somewhere between retail brokers and institutional salespeople, they provide brokerage and money management services for extremely wealthy individuals. Salespeople make money through commissions on trades made through their firms.
Traders also provide a very important role for the investment bank. Traders provide the buying and selling of stock, bonds, or other securities such as currencies, either by carrying an inventory of securities for sale or by carrying out a given trade for a client. Traders deal with transactions large and small and provide liquidity for the market (This is often called making a market.) Traders make money by purchasing securities and selling them at a comparatively higher price. This price difference is called as "bid-ask spread."
Research analysts go behind stocks and bonds and after making analysis make recommendations on whether to buy, sell, or hold those securities. Stock analysts/equity analysts typically focus on one industry and will cover up to 20 companies' stocks at any point of time. Some research analysts work on fixed income side and will cover a particular segment, such as high yield bonds or Treasury bonds. Salespeople within the Investment bank use the same research reports published by analysts to convince their clients to buy or sell securities. Corporate finance bankers depend on research analysts to be experts in the industry in which they are working. Reputed research analysts can generate extensive corporate finance business as well as substantial trading activity, and thus are an integral part of any investment bank.
Syndicate exists to facilitate the placing of securities in a public offering. They provide a vital link between salespeople and corporate finance. In a corporate or municipal debt deal, syndicate also determines the allocation of bonds. The breakdown of these fundamental areas differs to some extent from firm to firm.