Investment banking is a key element of the financial world because of the role it plays in raising capital and brokering deals for corporations and other entities. Investment banks tend to be large, international operations these days, but they got their start in the U.S. by selling government bonds used to fund the Civil War. By the turn of the century, the industry had grown considerably, producing giants like J.P. Morgan and Goldman Sachs that are still in business today.
What Is Investment Banking?
Modern investment banking involves a wide range of products and services to corporations, institutions and government entities. The banks themselves are often divisions of larger financial institutions, handling any number of tasks. Here are some of their key functions:
- Raising capital
- Financing large projects
- Advising clients
- Issuing bonds
- Managing assets
- Determining IPO prices
- Facilitating mergers and acquisitions
- Buying and selling securities
What Does Investment Banking Entail?
Most investment banks are part of larger banks. You’ve probably heard of many of them, including Goldman Sachs, Morgan Stanley and Deutsche Bank. Here are some of the other leading investment banks:
There are two main types of investment banking: the buy side and the sell side. Here’s how their work compares:
- Buy-side investment banking involves buying and creating securities such as stocks, bonds, mutual funds and derivatives. Professionals on this side manage clients’ money, work to grow assets under management, and decide when to buy, hold or sell securities.
- Sell-side investment banking takes the above securities and products to the market. Professionals on this side conduct research, advise clients on transactions, help raise capital, make M&A recommendations, close deals, manage client relations and try to generate new business.
How Do Investment Banks Work?
Investment banks tend to work behind the scenes, brokering business deals, selling securities and promoting business growth. The work they do can have a significant impact on the markets and the broader economy.
As investment banks match sellers and investors, they inject liquidity into the markets. They also help companies as they prepare to go public, which creates investment opportunities and puts even more money into the markets.
What Is Investment Banking’s Function?
Investment banks have numerous functions for clients, but among the most important are facilitating deals and raising money for clients.
For example, say ABC Inc. wants to build a new vacation resort. The owner contacts an investment banker to discuss the idea. The banker puts ABC in touch with XYZ Corp., which owns several hundred acres of land along a freshwater lake.
The owners of ABC need money to purchase the land, raw materials and other goods and services necessary to construct the resort. The investment banker can help raise capital by issuing bonds and selling them to investors.
But the work might not end there. Suppose ABC eventually decides to split the company into two divisions to support the new resort. The investment bank can assist the owners through that process and then prepare an initial public offering for the new company. Part of this process requires setting the price for the IPO, which the investment bank helps determine.
Differences Between Investment and Traditional Banks
Banking falls into two main categories: traditional and investment. Most consumers are familiar with traditional banking, also knows as retail banking or commercial banking. Here’s a glimpse at some of the differences between investment banks and traditional banks:
|Feature||Investment Bank||Traditional Bank|
|Regulatory authorities||U.S. Securities and Exchange Commission||
One of the biggest differences between investment and traditional banks is that investment banks don’t accept deposits, and traditional banks do. You won’t visit an investment bank to set up a personal checking account. Nor will you see a government agency stop at a local bank branch to apply for a loan. The two banking types have very different customers who have very different needs.
Investment banks sell and manage securities and other products. These include the following:
A commercial bank offers checking, savings, money market and other deposit accounts, as well as loans and credit cards. Some also provide wealth management services and financial advice.
Services provided by investment banks include issuing bonds, brokering deals, raising capital, setting prices for IPOs and facilitating mergers. Traditional banks can offer similar services, such as financial advising. They also process more basic bank transactions for their customers.
Another important distinction between investment and traditional banks is oversight. Investment banks are regulated by the SEC. This is because of the banks’ role in creating and promoting securities. Traditional banks are regulated by different agencies for different functions, including the FDIC, OCC and Federal Reserve.
What You Need To Know About Investment Banking
Even if you don’t work for or do business with an investment bank, understanding what they are and how they operate gives you a better understanding of the industry. These banks provide important services to corporations and governments that do play a role in your everyday life.
This article has been updated with additional reporting since its original publication.