By definition, both investment banks and commercial banks form the categories of banking. By role, both differ substantially from each other. As an individual, you would have visited commercial bank branches many times and must be aware of their products and services. Investment banks are large financial institutions operating with large corporate customers.
Investment Banks are the lenders, mediators, and organizers for large financial institutes. Their role is often helping these corporate organizations with mergers and acquisitions, lending facilities, and advisory services. Large investments include JP Morgan Chase, Deutsche Bank, Goldman Sachs, etc.
Commercial Banks are the facilitators for individuals and businesses for money management through accounts and certificates, offering finance, and investment opportunities. Large commercial banks include Bank of China, Wells Fargo, Bank of America, Citi Group, HSBC, BNP Paribas, etc. So how do investment banks differ from commercial banks?
By definition, it should be clear that both types of banks deal with totally different sizes of clients. Investment banks offer advisory services with large financing facilities and securities investments. They are often the organizers of the business mergers or acquisition transactions. They also help not-for-profit funds such as insurance or retirement funds to invest in ETFs or securities. These banks mainly operate with large corporate clients seeking mediatory (more of a guarantor) role with financing, investment, and acquisition transactions at large scale.
Commercial banks make profits with customers’ deposits and investing them in higher return securities, often handled by investment banks. Their prime job is to offer individual and business customers with daily banking services. These banks also offer investment, financing, and financial advisory services at a relatively smaller scale.
Essentially both types of banks offer the same services that can be categorized as financing, investment, and advisory. However, the scales at which these banks operate differ. Some key differences at scale and procedural level can be termed as:
Investment bank clients are corporate businesses and large institutes, commercial banks deal with individual and smaller businesses. Investment banks facilitate corporate customers with investments through bonds, securities, and stocks. Commercial banks offer investment through fixed deposits and shares.
Commercial banks are highly litigated and backed by Federal government guarantees. Investment banks enjoy relatively lesser federal litigation restrictions.
Customer funds with commercial banks are secured with federal government and securities commission or central banks.
Corporate clients and large institutions such as insurance companies, NGOs, and other corporations need investments to make profits. Investment banks play the role of a financial advisor for these institutes with investments in growth stocks, ETFs, and bonds and securities. These institutes often need advice on their risk management with currency translations, interest rate fluctuations, and stock trends. Investment banks provide risk-hedging facilities to these multi-national corporate clients through Forwards and Futures contracts. Their clients also include money transfer exchanges and national government institutes requiring large sums of money translations and transactions.
Although commercial banks also do offer similar services to their clients but their clients are individuals and smaller corporate businesses. For individuals, their services are basic banking facilities with accounts, loans, and profit certificates. Their services to corporate customers include lending, investment, and foreign exchange transfers. These banks make profits on interest charged to their borrowers, both individual and corporate, and by investments with investment banks and securities.
Investment And Commercial Banking Combined:
Although the investment and commercial banking roles differ, many institutes offer both services. In fact, many financial conglomerate institutes combine Insurance with commercial and investment banking services. These combined roles of both commercial banking and investment banking have often irked criticism with conflict of interest issues. As investment banks are the prime financial advisors with mergers, investments in trade, and financiers, their multiple-role playing has often been under criticism. Regulatory institutes such as the securities exchange commission (SEC) have far lesser control over investment banks than commercial banks. The critics often relate investment banks’ total control with market monopoly as market makers and swingers terms. Similarly, investment banks play a financial advisory and research role with equity trading for corporate investors, which again creates a chance of manipulation. These conflicts of interests’ voices get louder with an economic slump situation such as the Global financial crunch in 2008.
Commercial banks face much more regulatory restrictions from governments and authorities than investment banks. They are bound to protect investors’ money, customers’ funds, and oblige the competitive monopoly regulations. These tougher restrictions also mean commercial banks make less risky investments or policies. Customer funds with commercial banks are fully backed by government guarantees. On the other hand, investment banks face less litigation and regulatory restrictions. Take it either way, it allows investment banks to make risky investments and make larger profits, or enjoy market “control”. However, all corporate transactions including mergers and acquisitions, trade deals, and financial advisory services do include certain agreed terms and conditions. Higher investment returns from investment banks, liquidity facilitation, and heavy pay packages, are sort of compensation terms offered by investment banks.
Regardless of nature and scale, both investment and corporate banks form the integral parts of the banking system. Eventually, both banking divisions complement each other. We hope that you found out how do investment banks differ from commercial banks!