Investment banking has been a fancy profession and investment bankers are desirable. But there’s little knowledge on how investment banks work or make money.
First, investment banks work on a completely different model than commercial banks. Unlike commercial banks which take interest on loans, mortgage, and deposits, investment banks take commission on equity trade, financial advisory, and merger and acquisitions.
They deal with investment-related and asset management activities.
There are four major ways how investment banks operate:
Advisory and consulting service:
Large corporations tend to focus on growth and thus finances thus take a backseat. Similarly, people with high wealth, tend to get busier and hardly take out time to manage their wealth. These are referred to as HNWIs ( High Net Worth Individuals)
Here investment banks or investment bankers can help. Corporations require support for IPO (Initial Public Offering), strategy development and execution. HNWIs need support for expenditure, savings, taxation, and insurance.
This is a major task for investment banks and professionals.
Underwriting is to assess the risk associated with any financial transactions such as insurance, buying or selling stocks, and even while taking or receiving loan.
Small investment banks majorly are involved in underwriting securities, which is buying and selling stocks. This is an essential IPO procedure. Most of them make money this way.
Asset and wealth management
This is one of the key differentiating feature between large investment banks and boutique investment banks.
As part of this, larger investment banks take care of corporate wealth and manage private funds. Further, they collaborate with other financial bodies involved such as hedge and mutual funds and trusts.
Mergers & acquisitions
M&As are popular option for businesses to expand and acquire bigger market share.
Business leaders take help of banks to finalize M&As deals. This to make an informed decision.
Banks follow a rigorous process to ascertain the value of both businesses, do market research, suggest a M& A model and also raise funds in case required.
Most of the tasks carried out by investment banks can be easily put under the above four. Additionally, there are other activities that might be differ from banks to banks.
How do these investment banks make money?
Investment banks essentially act as middle men between companies, institutions and investors. They majorly help with IPO which is a major means to raise capital for businesses.
So does this help investment banks make money?
Most investment banks make money in the following three ways:
- Commission: As described earlier, an investment bank can be involved in multiple ways with a company. Based on the work involved – M&A, securities trading, and more. Investment bank may take a percentage of cut of the total transaction value or involved parties can decide as they feel
- Dividends and interests: This is a part of recurring revenue for investment banks and is derived from interests taken from provided loans or equity investments.
- Other sources of revenue: Varying across banks, there could be other sources of revenue as well.