An investment bank is a large financial institution that works primarily in high finance. The organization helps companies access capital markets, such as stock and bond markets. This helps raise money for expansion or other needs.
Learn more about investment banks, how they work, and their role in financial markets.
What Is an Investment Bank?
An investment bank is a special type of financial institution. It aims to help companies access capital markets to raise money and take care of other business needs. A typical investment bank may:
- Raise equity capital.
- Raise debt capital.
- Insure bonds or launching new products.
- Engage in proprietary trading. Teams of in-house money managers may invest or trade the company's own money for its private account.
For instance, let's say XYZ company wanted to sell $10 billion worth of bonds to build new plants in Asia. An investment bank would help it find buyers for the bonds and handle the paperwork; it would do so along with a team of lawyers and accountants.
Investment banks can also be involved in initial public offerings (IPOs). This is when a private market goes public and lists one of the exchanges.
Well-known investment banks include Goldman Sachs, Bank of America, Morgan Stanley, and Citigroup, to name a few.
How Do Investment Banks Work?
Investment banks are often divided into two camps: the buy-side and sell-side. But many offer both buy-side and sell-side services. The sell-side often refers to selling shares of newly issued IPOs, placing new bond issues, engaging in market-making services, or helping clients facilitate transactions.
In contrast, the buy-side works with pension funds, mutual funds, hedge funds, and the investing public. The aim is to help them maximize their returns when trading or investing in securities such as stocks and bonds.
Many investment banks are divided into three divisions; they are based on the services provided and the employees' responsibilities:
- Front office
- Middle office
- Back office
Front-office services typically consist of:
- Helping companies in mergers and acquisitions.
- Corporate finance (such as issuing billions of dollars in commercial paper to help fund day-to-day operations).
- Professional investment management for institutions or high net worth individuals.
- Merchant banking.
- Investment and capital market research reports prepared by professional analysts.
- Strategy formulation.
Middle-office investment banking services include compliance with government regulations and restrictions for professional clients such as banks, insurance companies, and finance divisions, as well as capital flows.
These are the people who watch the money coming into and out of the firm; this helps to determine the amount of liquidity the company needs to keep on hand so that it doesn't get into financial trouble. The team in charge of capital flows can use that information to restrict trades by reducing the buying and trading power available for other divisions.
The back-office services include the nuts and bolts of the investment bank. It handles things like:
- Ensuring that the correct securities are bought, sold, and settled for the correct amounts.
- Making sure the software and technology platforms that allow traders to do their jobs are state-of-the-art and functional.
- Creating new trading algorithms.
Back-office jobs are often seen as unglamorous. Some investment banks outsource to specialty shops such as custodial companies. But they allow the whole thing to run. Without them, nothing else would be possible.
Investment Banks vs. Commercial Banks
|Investment Bank||Commercial Bank|
|Doesn't accept deposits||Accepts deposits|
|Doesn't provide loans||Provides loans|
|Targets larger corporations and high net worth individuals||Targets all consumers, small to large size corporations, and governments.|
|Regulated by the country's security agency||Regulated by the country's central bank|
There's one main difference between investment and commercial banks. Investment banks focus on helping businesses access capital markets. Commercial banks primarily deal with deposit accounts and loans for individuals and companies.
Until recent decades, investment banks in the U.S. were not allowed to be part of a larger commercial bank. That's because the activities posed far more risk than the traditional lending of money done by commercial banks. However, they could be very profitable if managed well,
- Investment banks help corporations access capital markets.
- Companies use investment banks for their initial public offerings (IPOs).
- Investment banks typically handle a company's merger or acquisitions.
- Commercial banks focus on deposits and loans; investment banks don't.