What is Investment Bank? | Definition, Working, Pros and Cons

Banking is a service that everyone uses, whether it is an individual, small business, big corporation, or government. Individuals and small businesses often use commercial banks for their day-to-day financial activity, where big corporations and governments use investment banks for financial operations. These banks operate with different principal than other banks and often deal with large amounts of money. Different capital markets around the world depend on these banks. Investment banks are as important as commercial banks and they do play a major role in an economy. Let’s learn how investment banks work and what are the advantages and disadvantages associated with investment banks.

How does it work?

An Investment bank is a financial institution that intermediate large financial transactions for the corporate, capital market, and governments. Unlike other small banks, investment banks do transactions in millions and billions. These types of banks usually help big corporations with mergers, acquisitions, capital raises, and other advisory services. In short, Investment banks are a type of financial institution for the capital market.

In the USA topmost investment banks are City Group, J.P Morgan Chase, Morgan Stanley, Goldman Sachs, and Bank of America Merrill Lynch. Most big business-related financial transactions are done through these banks. Often large companies use these banks for selling their bonds and IPOs. These banks also manage trillions of dollars worth of financial assets. Contrary to commercial banks, investment banks take more risk and generally gain more profit.

Unlike a commercial bank, Investment banks never accept deposits from common citizens. They also do not provide small loans to anyone. However, the government can use them to give loans to other institutions or governments. Investment banks only deal with high net worth individuals and large corporations. These banks do not follow the regulation of any central bank. Instead, these banks work closely with the nation’s security agency.

Advantages of Investment Banks

Investment banks control lots of capital. For this reason, these banks can finance big projects like a dam, railroad, etc. Without the support of investment banks, large infrastructural projects are not possible. These banks contribute a lot to the nation’s economy. Thanks to the investment of these banks, major businesses can flourish well. These banks also work as a mediator between large corporations and make big business deals possible. The security infrastructure of investment banks is very tight. Hence, we don’t see any major corruption or fraud in these banks.

Disadvantages of Investment Banks

There are also multiple disadvantages associated with investment banks. All investment banks do not serve common people or small businesses. Ordinary people cannot deposit or take a loan out of these banks. These banks only serve wealthy individuals and big businesses.

Another problem of investment banks is that these banks do businesses with lots of capital. For this reason, any problem with these banks could put a severe effect on the economy. Many countries faced a recession when their investment bank faced bankruptcy. Even though investment banks generate lots of capital but these banks also take a huge amount of risk with their investment.

References

  1. https://onlinelibrary.wiley.com/doi/abs/10.1111/j.1540-6261.2005.00815.x
  2. http://www.truevaluemetrics.org/DBpdfs/DevelopmentAssistance/AIDB-Asian-Infrastructure-Development-Bank-by-CRS-2017.pdf