Investment and commercial banks are the two vital pillars of the global banking industry. One supports the other, and both, co-exist beautifully together. On one hand, commercial banks allow individuals to collect their savings in a secure facility(bank) and earn interest on the same, on the other hand, investment banks facilitate capital investment in the financial markets on behalf of wealthy individuals and institutions.
Key Differences Between the Functionalities of the Two
Investment banks make the process of purchase and sales of stocks, bonds, and shares simpler for high net worth individuals and large institutions. They help privately-owned companies break into the public domain by facilitating the paperwork and formalities required to enter IPOs (Initial Public Offerings). As a matter of fact, banking professionals in the investment banking sector make way more than a commercial bank employee.
Commercial banks manage individuals’ financial savings and deposits made by businesses. Primarily, commercial banks cater to businesses’ capital, as it empowers them to extend big loans to individuals and firms through which they make their money via charging interest.
After the great recession of 2008, many banking institutions started operating both the arms of the banking sector, i.e. investment banking and commercial banking, within a single roof under the same name. The result was intense scrutiny by the government over the operations. However, numerous financial firms and banks at present juggle with both at the same time and had been successful at doing this in the past, the debate continues on whether it should be permissible by the authorities or not.
The Dissimilarities in a Nutshell
- Commercial banks and investment banks offer a different set of financial services.
- Investment banking entities underwrite equity securities and debts, assist with the sale of securities, and support merger and acquisition activities.
- Commercial banks lend loans to individuals and SMEs. Their major financial offering is to provide people and businesses with a safe and secure savings account from where they can withdraw money whenever needed, unless there is a participation in a scheme where you fix your deposit for a certain duration to earn higher interests.
- Majority of financial services entities function either as a commercial bank or an investment bank, although a few combine both.
Factors That Separate Investment Banking Industry from Commercial Banking
The big difference lies in the type of clientele each possesses. While investment banks cater to large institutions and corporations, commercial banks, on the other hand, primarily serve the general public.
Both arms of the banking system provide for a completely different set of financial services. Investment banks handle huge capitals received from their high-end clients for strategic investment into financial markets. Commercial banks handle a significantly low amount of funds received from the general public and small businesses.
Investment banks are affected by the performance of the stock markets in the country of establishment, as well as the international financial markets. Commercial banks, however, do not get much affected by the performance of share markets in general, but their performance is closely linked with the country’s economic growth, and the decisions taken by the federal banks.
The Case for Financial Entities that Combine Both the Functionalities
History tells us that there had existed institutions that combined the two arms under one roof, and offered both the functionalities. However, such entities were never seen as benefiting enterprises in the context of nation-building, and hence, seen with a sceptical lens. Some industry experts have gone as far as linking such institutions with economic downturn witnessed in the early 20th century.
The year 1933 called for the launch of a formal bill against the provision in the name of “Glass-Steagall Act”. The act demanded a total separation of the banking activities concerned with commercial and investment banking. The act, later got dissolved in the 1990s. Since then, banking entities had been running both types of operations under one name.