How Do Investment Banks Make Money?
Making money or how to make money is a topic that is always of great interest to everyone. Although many people are interested in making more money, saving, and even growing their money, not everyone knows the importance of investment banks or what they do.
Investment banks are, of course, different from regular commercial banks, They are interested in bigger accounts, and they don’t take deposits. They finance trades and investments on a larger scale for institutional clients. Other than these, there are several ways investment banks make their money. So here’s all you need to know.
What are Investment banks?
Investment banks are banks that are interested in investments. They are a financial institution that helps big companies and governments access the capital markets to raise capital and make available financial consultancy to these companies.
Investment banks are different commercial or savings banks. They do not accept deposits, do not provide loans, and their target customers are big companies, corporations, and individuals with a high net worth or even the government.
They serve as middlemen between those with money and those with ideas that need money. Examples of investment banks are Bank of America, Barclays, Deutsche Bank, Goldman Sachs, and BNP Paribas.
What do Investment banks do?
Investment banks do many things, but the first job of investment banks is to make available capital for their customers. They provide services like trading, underwriting, and advice on mergers and acquisitions.
They also offer financial consultancy. For instance, if an investment bank’s client is considering a merger with another company or buying another company out, or maybe a company wants to divest a subsidiary account, the investment company will offer their assistance.
The investment bank will first approach the other company to know how much they’re worth before suggesting how best to structure the deal for their client to avoid losses.
Their services also include underwriting new debt and equity securities for all types of companies. They also act as middlemen between security issuers and potential investors, part of their services is to help new firms go public.
What’s more, they lend money to firms to purchase assets and settle acquisitions, and they also provide acquisition advisories. They take the pain to research and assist investors in deciding which securities to buy to ensure that their clients are not involved in bad deals. In fact, investment banks play the role of a big brother.
Apart from these, they help their clients trade with each other (brokerage) and invest their money in projects themselves instead of finding investors (private equity). Investment banks provide equity financing.
This is when they look for investors to invest directly in the company by becoming shareholders. These investors become part owners of the company, and a part of the provider comes to them.
Interestingly, investment banks insure bonds or the launching of new products. Companies also use investment banks for their initial public offerings (IPOs). They help manage their client’s assets.
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How do Investment banks make their money?
Investment banks offer lots of services, so they have multiple streams of income. Here are some of the ways investment banks make their money include:
1. Advisory Fees.
As was stated earlier in this article, investment banks play the role of big brothers to their clients; they advise their clients on the right deals to be involved with. They have in-depth knowledge about the status of the financial markets. Because of their vast financial knowledge, clients come to them for advice.
If a company wants to raise capital through a public issue, they often consult investment banks for advice. Interestingly, investment banks have departments designated to be financial advisories, and big institutions, companies, and even the government consult them for advice.
When they want to raise funds, they advise them on a potential market, if it can be tapped, and the appropriate timing to bring out a public issue. Due to their expertise in this regard, the investment banks attach a high consulting fee for their services. This fee depends on the amount of time spent with the client.
2. Trading Income.
Investment banks usually have very active trading desks. They invest money on behalf of their clients. If the client adheres to their advice and makes an above-average return, the investment banks take a small percentage of the above-average return.
These are usually called asset management fees. Also, the investment banks have their proprietary trading desks where they invest their own money, not their client’s money this time. Since they are investing their own money, they get to keep the profit from their investment. This is another source of income for investment banks.
3. Underwriting Services.
The main job of big investment banks is to help private companies go public. This means they help these companies sell shares in the open market. While doing this, they underwrite all the shares. This means that the risk that if any of these shares are not sold to the common market, they will buy the shares themselves.
These public issues usually cost a lot of money, running into hundreds of dollars, and Investment banks charge huge commissions for the size of the issue. This way, they gain millions of dollars from these commissions.
You should know that only the services of the biggest and most trustworthy banks are taken. So the underwriting income is concentrated within a few companies.
4. Research Fees.
Research fees are another way investment banks make their money. Usually, they carry out lots of research on behalf of their clients. They hire the services of a lot of research analysts to ensure they give their clients up-to-date information.
The research reports created by investment banks have a lot of value because of their expertise in this field, and companies or individuals pay huge fees to access these reports, and investment companies have no option but to pay the research fees.
Investment banks make their money through swaps sometimes. Swaps create profit opportunities through a complicated form of arbitrage where an investment bank brokers a deal between two client parties that are trading their cash flows individually.
The most common swaps occur whenever two parties realize they might mutually benefit from a change in a benchmark, for example, exchange rates. This is another way investment banks make their money.
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What’s the difference between Investment banks and Commercial banks?
Firstly, commercial banks accept deposits, and investment banks do not. Anybody can be a customer of a commercial bank, while customers for investment banks are specific. They are people or companies with high net worth.
Investment banks clients are larger and more experienced organizations with bigger funding needs, unlike commercial banks with just an average student as customers.
Investment banks are regulated by the country’s security agency, while The country’s central bank regulates commercial banks.
What is the structure of an investment bank?
An investment bank is often divided into two departments: the ‘buy side’ and the ‘sell-side,’ but many investment banks offer both the services of the buy-side and the sell-side. The sell-side is concerned with selling shares of newly issued IPOs, engaging in market-making services, helping clients facilitate transactions, and placing new bond issues.
The buy-side has to do with pension funds, mutual funds, and hedge funds. They also assist institutions that invest in maximizing their returns when trading/ investing in securities like stocks or bonds.
Apart from the buy and sell sides, most investment banks are categorized as front office, middle office, and back office.
- Front office
Front office services include one-on-one engagements with clients and market participants, corporate finance, professional investment management for companies or organizations, and high net worth individuals.
They also help companies with mergers and acquisitions, merchant banking, strategy formulation, professional analysis of companies and markets, and investment and capital market research reports prepared by professional analysts.
- Middle office
Middle office investment bank services include specialist activities like treasury, compliance and government regulations, and restrictions for professional clients such as insurance companies and banks.
What’s more, they offer risk management and cash flow services. This helps monitor the money coming in and out of the company and helps determine the amount of capital the company needs so it doesn’t get into any financial difficulty.
The middle office team in charge of capital flows is then expected to use that information to restrict trades by reducing the ability for these companies to have the buy and sell options available.
- The Back-office
The services of the back office are very important. It is the nut that brings the services of the investment banks together and enables work efficiently. Back office services include ensuring that the correct securities are bought, sold, and settled for the correct amounts.
They make sure the software and technology platforms that allow traders to do their jobs are updated, functional, and the best. They are also involved in creating new trade algorithms.
Every big company or individual with a high net worth needs an investment company. If they want to succeed, grow their income or business, they should engage the services of an investment bank. Are you looking to be an investment banker? Then you should know there are loads of ways to make money.