How Do Investment Banks Make Money?

Investment banks are like brokers: They help people trade stocks, bonds, commodities, currencies, etc.

How Do Investment Banks Make Money

Brokers usually charge commissions on trades, but some offer free accounts. Some charges include transaction costs, brokerage fees, account maintenance fees, and others.

The trades vary in size depending on the type of security being traded. Smaller transactions cost less, while larger ones cost more.

Some investments require special licences, such as those involving derivatives and futures contracts. These licences are expensive and must be obtained before trading begins.

Underwriting involves making sure that a company issuing securities meets certain requirements, such as having enough cash to cover future debt payments. This ensures that investors don’t lose money on the deal.

An investment bank might buy stock in a company’s IPO, and then market the shares once they go on sale.

There is a risk that the investment bank will be unable to unload the shares for a higher value, so it might lose money on the deal, known as a failed IPO.

Why Do They Make So Much Money ?

Directors, principals, and managing directors at bulge-bracket financial institutions earn huge sums of money because they often oversee transactions worth hundreds of millions of dollars.

At the director level and up there is a responsibility to manage teams of analysts and associates, broken down into product lines, including equity and debt capital raising and M&A, as well as sector coverage; a huge responsibility!

Fees

There are several types of fees banks can charge customers. Some of the most common include overdraft charges, returned items fees, ATM fees, foreign exchange fees, wire transfer fees, etc.

These fees usually apply to transactions involving currency exchanges. They tend to range from 0% to 2%.

Net Interest Margin 

When it comes to commercial banking — especially retail banking — net interest margin (NIM) is the primary source of revenue. In fact, according to Bank rate, “The average U.S. consumer bank earns about 4% on every dollar deposited.”

What does that mean? Well, let’s say you deposit $1,000 into a checking account at a local credit union. Your credit union might charge you a fee of around 0.5%, meaning you’ll earn $50 in interest over the course of one year.

If you put another $1,000 into that same account, you’d earn another $50 in interest. So, the total amount of money you’ve earned is $100. However, since you’re paying fees, your actual profit is closer to zero.

So what happens if you move up to a bigger bank? You might find yourself earning less interest, because big banks usually pay out less interest than smaller banks do.

But, if you keep putting money in your account, you could still make some decent profits.

For example, if you opened a savings account at a large national bank, you might earn 3% interest per year. Over 10 years, that adds up to $300. Now, let’s say you put $10,000 into that account.

After accounting for the annual fees, you’ll end up making a total of $320 in interest.

So, while you won’t be making nearly as much money as you did at the small credit union, you’ll still come away ahead of where you started.

All the same?

Investment banking is where you go to raise capital for companies, while commercial banking is about providing loans and managing deposits.

But many banks today are not strictly investment banks or strictly commercial banks; rather, they’re hybrids of the two. Some banks avoid investment banking altogether, focusing solely on commercial banking.

Others offer some investment banking services, but mostly stick to commercial banking. Still others focus primarily on investment banking. And it’s rare to find a bank that focuses exclusively on commercial banking.

The big three American banks — JPMorgan Chase & Co. (NYSE:JPM), Bank of America Corp. (NYSE:BAC) and Citigroup Inc. (NYSE:C)—are examples of banks that are predominantly commercial banks.

They tend to do well in areas such as consumer lending, mortgages and personal finance.

Goldman Sachs and Morgan Stanley are examples of banks that specialize in investment banking. Both firms provide advice to corporate clients on mergers and acquisitions, public offerings and restructurings.

Their businesses include equity underwriting, debt trading, research and advisory services.

Advisories 

Another role of an investment bank is to provide financial advice to a client.

How Do Investment Banks Make Money (1)

This includes helping companies make decisions about whether to buy or sell businesses, how much money they want to spend, what type of loan they require, and where they are able to find it.

An adviser works with clients to help them achieve their goals. They do this by providing expert guidance based on their experience and expertise.

One issue they advise on is merger and acquisition (M&A), including when:

a company is looking to acquire another one (for example, it could be looking to expand into a new market)

a company is looking for ways to reduce costs

an owner wants to sell their business

Wider Society 

Investment banking is one of the world’s oldest professions, having been around since ancient times. In fact, it dates back to Babylonian traders and merchants who used money lenders to finance trade deals.

Today, investment bankers help businesses raise capital, manage risk and invest in growth opportunities.

They do this by providing expert advice and services to clients across a range of industries, including manufacturing, technology, energy, healthcare, media and communications, consumer products, food and drink, life sciences, fashion, and retailing.

The industry is highly competitive, with some firms employing hundreds of thousands of people worldwide. There are about 2,500 investment banks operating today, although there are fewer than 10,000 jobs globally.

This number is expected to rise slightly over the next few years, however, as the global economy continues to recover.

Conclusion 

Investment banking is a lucrative career, but isn’t for the fainthearted. Investment banking requires nerves of steel, but if you’re up to the job you will be financially secure for life.

Luke Baldwin
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