Differentiating Investment Banking and Commercial Banking

Two of the major players in the financial services industries are investment banking and commercial banking. Even though many companies provide commercial and investment banking services to their clients, there are significant distinctions between them.

Typically, when people think of “the bank,” commercial banks come to mind. This is where people deposits, protect assets, and obtain and manage loans. Essentially, commercial banks cater to the general public and handle everyday financial services.

Commercial banks are also dedicated to meeting the financial requirements of medium to small-scale businesses, not just private individuals. They can help these business manage their day-to-day treasury operations such as foreign currency exchange, processing payments, and basic cash management. These banks also have credit facilities, like overdrafts, mortgages, and acquisition-related financing. Commercial banks make their money through the service fees and loan interest rates imposed on customers.

All commercial banks are set up through a federal government charter. In other situations, they function under a state’s charter. However, they must join the Federal Reserve System, which imposes stricter capital requirements.

If a commercial bank fails or crashes, all its customers are protected by deposit insurance overseen by government entities like the Federal Deposit Insurance Corporation (FDIC). This insurance is a crucial earmark of commercial banks, and certain countries guarantee deposits of up to $250,000.

Conversely, investment banks are designed to offer money-making financial services to large corporate institutions, governments, and investors. Even though there are several factors, including regulation, benefits, and risk, the major difference between the two is the scale of operation.

Investment banking primarily offers the trading of bonds and stocks to their clients (corporations, investors, and government). Therefore, the performance of investment banks is directly affected by how the stock market behaves. The bank helps create and manage capital for its client at its core. They also have secondary functions, including helping with mergers and acquisitions, underwriting equity and securities, brokerage and shares, and many more. These banks also offer financial advice to the large entities that frequently use them to facilitate business. They are especially
helpful in advising on sales and trade of companies.

Investment banks fall into two categories based on operation: industry and product groups. While the investment bank product groups offer leveraged finance, mergers and acquisition, and leveraged finance, they also help companies restructure to become more financially efficient. The industry groups help meet the needs of specific core sectors like healthcare, finance, technology, and real estate.

While organizations like the FDIC oversee and regulate commercial banks, investment banks are regulated by the Securities and Exchange Commission (SEC), which gives them more freedom in decision making and capital management.

In the late 1920s and early 1930s, during the Great Depression, the law allowed banks to integrate commercial and investment functions. Many people viewed this as one of the things that contributed to the depression. But it remained this way until 1933 when the Glass-Steagall Act divided the functions under the Banking Act. However, the Glass-Steagall Act was abolished by the Gramm-Leach-Bliley Act in 1999, and banks were allowed to merge functions once more, although many banks have decided to retain the split.

Jerry Cain — Experienced Managing Director at Slate Asset Management