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, whereas big corporations and governments use investment banks for financial operations. These banks operate with different principal than others 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 play a major role in an economy. Let’s learn how investment banks work and the advantages and disadvantages associated with investment banks.
Key Takeaways
- Investment banking is a specialized area of banking that focuses on raising capital for companies, governments, and other organizations through the issuance of securities, such as stocks and bonds.
- Investment banks also provide advisory services to clients on mergers and acquisitions, financial restructuring, and other strategic transactions, as well as trading and market-making services in securities and derivatives.
- Investment banks play a crucial role in the global economy by facilitating the flow of capital and providing financial expertise and services to businesses and investors.
How does it work?
An Investment bank is an institution that intermediates 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 help big corporations with mergers, acquisitions, capital raises, and other advisory services. In short, Investment banks are a financial institution for the capital market.
The USA’s 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 to sell their bonds and IPOs. These banks also manage trillions of dollars worth of financial assets. Contrary to commercial banks, investment banks take more risks and generally gain more profit.
Unlike commercial banks, 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 other institutions or governments loans. 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, railroads, 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 mediate 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 with investment banks is that these banks do business with lots of capital. For this reason, any problem with these banks could severely affect the economy. Many countries faced a recession when their investment bank faced bankruptcy. Even though investment banks generate lots of capital, they also take a huge amount of risk with their investment.
- https://onlinelibrary.wiley.com/doi/abs/10.1111/j.1540-6261.2005.00815.x
- http://www.truevaluemetrics.org/DBpdfs/DevelopmentAssistance/AIDB-Asian-Infrastructure-Development-Bank-by-CRS-2017.pdf
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Chara Yadav holds MBA in Finance. Her goal is to simplify finance-related topics. She has worked in finance for about 25 years. She has held multiple finance and banking classes for business schools and communities. Read more at her bio page.
