How Investment Banks Make Money?

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Most banks offer different investment opportunities for their customers. Despite that there are traditional banks as well as investment banks. The term, investment banks, is heard quite often. In most of the cases it is overlooked and considered the same as a traditional bank. But that is not the case. This article explains how investment banks make money but before that one should know, the first and foremost thing i.e. to understand the difference between these kinds of banks.

Traditional Bank

Traditional banks are also known as retail banks. They take money from those customers which put their money in the bank to save it. Next, they give that money out to the borrowers in the form of loans, credit cards, or even mortgages. These banks make money by charging a higher interest rate from those who are borrowing the money as compared to providing the interest amount to those customers which are using the savings account.

Investment Bank

These banks do not earn their money through interest payments they receive from their clients. Their target customers are not regular customers. Instead, they target organizations, companies, fund collecting NGOs, and other fund offering government institutes. They offer their insight on stocks, and future financial market movement. For all these services they take a certain amount of fees or commission from their customer. This helps them earn large amounts of money.

Related: How Much Savings Should be Invested?

Skills in Investment Banking

Investment banking is not an easy job. It requires professional financial modeling skills along with valuation. Some of the skills which are required by the investment bankers are:

1)  Financial modeling

2)  Business valuation

3)  Negotiation

4)  Relationship management

5)  Sales and business development

Different Monetizing Services Offered by Investment Banks to Make Money

There are many services which are offered by investment banks to their clients. The services offered by investment banking plays an important role.

1.  Merger and Acquisition Advisory Services

Merger and Acquisition (M&A) advisory is the process of finding, evaluating, and performing the process of acquisition of various organizations in the market. Since the client-base of a bank is very large, they use their research capabilities and find the relevant organizations to acquire them. They can represent both the seller or the buyer side of the deal making the process a lot easier for either of the parties.

All of the negotiation is done on behalf of the customers. Banks provide a proper plan for the acquisition once they identify the target organization to be acquired. Through their extensive experience and knowledge, this process can be executed in the most appropriate and legally secure manner. All the required contract and its details are sorted out by the investment bank. Financing can be provided as well. Investment banks ensure that they are a part of the implementation process until the end. 

2.  Advisory for Banking Clients

Investment banking offers many pieces of advice for their clients. It could either be for capital raising or M&A. Investment banks can have the government as their client. With the government they can raise money, buy or sell crown corporations, and trade securities as well.

Apart from working with different government organizations, investment banking helps out different corporations in the public and private sector. They help with raising capital. They provide extensive market research to their clients to ensure that they remain on top of the competitors and gain maximum profits. Any corporate financial advice needed by the clients is also provided by investment banks. If a client wants to acquire or sell units of their organization, investment banks help out with those as well.

There are some investor institutions which manage large sums of money for other people. Investment bankers help them out by providing research on different stocks and properties. They also provide trade securities. Initial public offering (IPO) or selling to a strategic buyer is also offered by the investment banks to when selling such institutions to a strategic buyer. Using investment banking expertise, such institutions can also acquire different organizations.

Underwriting Services

The process of raising capital through selling of stocks or bonds to different investors and interested parties. These services are performed on behalf of different organizations. Investment banks provide underwriting services to gain investor’s money for their clients by marketing the client businesses to the investors. The raised capital by investment banking can be in the form of equity or debt securities. An underwriter can make three different types of commitment with an organization.

1.  Firm Commitment

When the underwriter makes a firm commitment with the client, the underwriter bears full responsibility for the share. It doesn’t matter whether the stock or the share is fully sold or not. The underwriter has to bear the financial cost in all situations. The entire issue needs to be sold. In this commitment the underwriter purchases the complete issue at a price.

2.  Best Efforts

In this kind of commitment, the underwriter does not define an amount or limit to the selling of the stock or share. As the name implies, they give their best effort in order to sell the maximum amount and gain benefit for the client. But no hard and fast implications along with liabilities exist for the underwriter if they are not able to sell the share or stock completely. This is the most common form of underwriting commitment made by investment banks.  

3.  All or none   

If an underwriter fails to sell all of their shares at the decided offering price, the deal is not valid and there is no profit for the underwriter in it.  

Conclusion

Investment banks are different from traditional banks in many ways. There are many different ways from which they can extract revenue as have been discussed above. They charge high amounts of fees for their services. They also buy and sell different stocks and keep a large amount of money for themselves. This is one of the major sources where investment banks make their money. The services that they offer may seem straightforward but they are quite complicated and require a lot of research and evaluation work. Bank of America, Citi, Deutsche Bank, and other similar banks are the number one investment banks. 

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