At its most basic, the banking industry acts as an intermediary between parties that can supply capital, and those that need it. The sector can be divided into two broad categories; investment banking and commercial banking. But exactly how is an investment bank different from a commercial bank? Well, read on to find out.
While the distinction between them is often blurred, investment banks and commercial banks are poles apart. Specifically, each of them provides markedly different services. The distinction expands to the scope of operation, target clientele, and governing regulations.
An Institution You Can Bank On
Commercial banks need no introduction to the average Joe/Jane — they’ve been in existence for almost as long as the concept of money has. Their main role within the financial landscape is to accept deposits and provide customers access to their funds through checking/savings accounts. A typical bank’s clientele will usually be comprised of both individuals and businesses.
The vast majority of commercial banks make money primarily by lending. Customer accounts provide the money needed to extend credit, with loans carrying higher interest rates compared to what they offer depositors. More income can be derived from providing safe deposit boxes, in addition to money order, wire transfer, and notary services. Some banks also dabble in the foreign exchange market.
A Financial Intermediary
If commercial banks are the gatekeepers of capital, investment banks can be thought of as real estate agents. They’re the go-to institution for entities looking to raise cash, including governments and corporations, as well as investors. In essence, investment banks act as intermediaries between these parties.
Picture a company looking for cash to start or grow their operations; an investment bank may help them in locating interested investors and n. Similarly, a government in need of funds for a public works project may seek assistance in issuing securities. Investment banks can also help clients analyze companies and rate their potential as investments.
Besides the commissions earned from trading activities, investment banks make money by levying fees for their services. To that end, some of them are known to run retail operations for individuals. This is in spite of the fact that their offerings are relevant only to a tiny percentage of the public.
That being said, the investment banking realm is wide enough to contain a couple of subsets. The institutions can be divided into:
- Boutique banks: Limited in scope but broad in expertise, such investment banks limit themselves to specific activities. That means they have smaller client bases compared to their counterparts.
- Full-service banks: Dabbling in a whole handful of activities, these banks act as one-stop shops. A typical full-service firm will have everything from underwriting and merchant banking to investment management in their banquet.
So, how is an investment bank, such as Chardan Captial, different from a commercial bank? Here are the key variations between the two:
- Visibility: Because commercial banks market their offerings directly to the general public, they enjoy a higher degree of visibility and recognition. Investment banks prefer to market themselves via business networks.
- Business model: Ordinary banks tend to operate on a volume-based model (i.e. deriving income from a high number of customers), whereas investment banks aim to maximize their margins.
- Service provision: To a large extent, commercial banks provide a standard service to their customers. On the other hand, the need to maximize margins means investment banks must tailor their services to match each clients’ needs.
- Regulation: Commercial banks operate in a very strict environment; it’s not unusual for their operations to be governed by several government organizations. By contrast, an investment bank only needs to obtain authorization from the securities regulatory body in any given country.
- Risk: The relaxed operating environment combined with the nature of their business gives investment banks more appetite for risk. That of course translates to a higher exposure to risk relative to commercial banks.
It’s worth noting most jurisdictions allow banks to combine investment and commercial branches under one roof. Even so, public concerns have enforced the need to maintain a firm boundary between the two.