Investment banks help companies and governments raise money and handle large financial deals, but they don't take deposits or offer checking accounts like your regular bank does.
An investment bank is a financial firm that specializes in moving large amounts of money between organizations. They underwrite stock and bond offerings, advise on mergers and acquisitions, trade securities, and manage complex financial transactions. Unlike a commercial bank—the kind where you have a checking account—an investment bank rarely deals with individual customers and doesn't hold your deposits.
The distinction matters because investment banks operate under different rules, take different kinds of risk, and serve a completely different purpose in the financial system. Understanding what they do helps explain why they show up in financial news and why their activities sometimes affect the broader economy.
Key Takeaways
- Investment banks raise money for companies and governments by selling stocks and bonds to investors, taking a fee for arranging the deal.
- They advise on mergers, acquisitions, and other major business deals, and they earn money by charging fees for that information.
- Investment banks trade securities and other financial instruments for their own accounts and for clients, which is how they generate trading profits.
- They do not take deposits from individuals or offer checking and savings accounts—that is the job of commercial banks.
- Investment banks are regulated differently than commercial banks and face different capital requirements and restrictions on the risks they can take.
How investment banks raise money for companies
When a company needs to raise capital—whether to expand, pay off debt, or fund operations—it often turns to an investment bank. The bank's job is to structure the deal and sell it to investors. This process is called underwriting.
In a typical stock offering, the investment bank agrees to buy all the shares the company wants to issue, then resells them to institutional investors like pension funds, mutual funds, and insurance companies. The bank keeps the difference between what it pays the company and what it collects from investors. For a large deal, that spread can be millions of dollars. The bank also charges an explicit fee, usually a percentage of the total amount raised.
The same process works for bonds. A company or government issues debt, the investment bank buys it and resells it to investors, and the bank collects fees and spreads. The bank's reputation and relationships with investors determine whether it can move a large offering quickly and at a favorable price for the issuer.
Advising on mergers and acquisitions
When one company wants to buy another, or when two companies consider merging, investment banks provide strategic and financial information. They help determine a fair price, structure the deal to minimize taxes, identify potential obstacles, and negotiate terms.
A company hiring an investment bank for a merger or acquisition typically pays a success fee—a percentage of the deal value, paid only if the transaction closes. For a billion-dollar acquisition, that fee might be tens of millions of dollars. The bank's advisors spend months on the deal, analyzing the target company's finances, identifying risks, and presenting options to the client's board.
Investment banks also advise on divestitures (selling off divisions), restructurings, and other major corporate changes. The work is lucrative but requires deep industry knowledge and strong relationships with corporate executives and boards.
Trading and market-making
Investment banks maintain large trading desks where they buy and sell stocks, bonds, currencies, commodities, and derivatives. Some of this trading is done on behalf of clients—a pension fund might ask the bank to buy a large block of shares, and the bank executes the trade. The bank charges a commission or takes a small spread.
Investment banks also trade for their own accounts, betting on price movements. A trading desk might buy bonds they believe are underpriced and sell them when the price rises. This proprietary trading can be highly profitable but also exposes the bank to significant losses if the market moves against them.
Market-making is another core function. Investment banks stand ready to buy and sell certain securities at quoted prices, providing liquidity to the market. They profit from the bid-ask spread—the difference between the price they pay to buy and the price they charge to sell. Without market-makers, large trades would be harder and more expensive to execute.
Why investment banks are separate from commercial banks
In the United States, the Glass-Steagall Act of 1933 separated commercial banking from investment banking. Commercial banks took deposits and made loans; investment banks raised capital and traded securities. The law was repealed in 1999, but the regulatory distinction remains.
Today, large financial institutions often own both a commercial bank and an investment bank under the same parent company. However, the two divisions operate under different rules. Commercial banks must maintain certain capital ratios and face restrictions on the risks they can take, because deposits are insured by the FDIC and the government has a stake in their stability. Investment banks face different capital requirements and can take more aggressive risks because they don't hold insured deposits.
This separation exists because the failure of an investment bank affects investors and other financial firms, while the failure of a commercial bank affects depositors and the payments system. The regulatory framework reflects those different consequences.
How investment banks make money
Investment banks generate revenue from several sources. Underwriting fees come from arranging stock and bond offerings. Advisory fees come from merger and acquisition work. Trading profits come from buying and selling securities. Commissions come from executing trades for clients. Some investment banks also manage money for wealthy individuals and institutions, charging a percentage of assets under management.
The mix varies by bank and by market conditions. In a strong economy with lots of mergers and new offerings, advisory and underwriting fees dominate. In volatile markets, trading profits can spike. During downturns, all revenue streams typically decline.
Investment banks also earn money by lending to companies and governments, though this is less central to their business than it is for commercial banks. They may provide bridge loans to finance a merger, or they may lend to corporate clients at rates higher than commercial banks charge, because the risk is higher.
The difference between investment banks and other financial firms
Investment banks are distinct from several other types of financial institutions. Commercial banks take deposits and make loans to individuals and businesses. Hedge funds manage money for wealthy investors and use aggressive strategies like short-selling and leverage. Private equity firms buy companies, improve them, and sell them for a profit. Mutual funds pool money from many investors and buy stocks and bonds.
Investment banks do some of what each of these firms do—they manage money, they lend, they buy and sell securities—but their core business is arranging large financial transactions and trading. They are also typically much larger and more complex than specialized firms, and they serve institutional clients rather than individuals.
Frequently Asked Questions
Can I open an account at an investment bank?
No. Investment banks do not offer checking or savings accounts to individuals. They serve corporations, governments, and institutional investors. If you want to invest in stocks or bonds, you would use a brokerage firm or a commercial bank's investment services, not an investment bank directly.
Why do investment banks sometimes fail?
Investment banks fail when they take losses they cannot absorb—usually from trading, lending, or underwriting bets that go wrong. Unlike commercial banks, investment banks don't have deposit insurance backing them. When an investment bank fails, its creditors and investors lose money, but depositors at the bank's commercial division are protected by FDIC insurance.
How much do investment bankers earn?
Investment bankers earn salaries plus bonuses. Entry-level analysts might earn $100,000 to $150,000 per year; senior managing directors can earn millions. Bonuses are tied to the deals the bank closes and the profits the bank generates. Compensation varies widely by firm, role, and market conditions.
What is the difference between an investment bank and a brokerage?
A brokerage executes trades for individual and institutional clients and charges commissions. An investment bank arranges large capital raises and mergers, advises on strategy, and trades for its own account. Some large firms operate both a brokerage and an investment bank, but the functions are distinct.
Do investment banks lend money?
Yes, but lending is not their primary business. Investment banks provide loans to corporations and governments, often at higher rates than commercial banks charge. They also provide bridge loans to finance mergers and acquisitions. However, most of their revenue comes from fees and trading, not from interest on loans.