Investment Bank

An investment bank is a financial firm that helps companies, governments and other institutions raise money in the capital markets, advises them on large transactions such as mergers and acquisitions, and buys, sells and makes markets in securities for clients. Its core customers are corporations, governments and institutional investors rather than households.

It differs from a commercial bank, which takes deposits and makes loans. Many of the largest institutions, such as JPMorgan Chase, Bank of America and Barclays, combine both under one group, while firms such as Goldman Sachs and Morgan Stanley grew up as investment banks. Investment banks are regulated by securities regulators, and those inside banking groups also by banking supervisors.

Think of an estate agent combined with a market trader. When a company wants to sell part of itself to the public or borrow from investors, the investment bank acts like the agent: it prices the property, finds buyers and handles the paperwork for a commission. Once the shares or bonds exist, the bank's trading desks act like the market trader, standing ready to buy from people who want to sell and sell to people who want to buy.

The bank earns fees from the first job and small margins, plus occasional gains or losses, from the second. It also gives advice, much as a good agent tells a seller whether an offer is fair, which is where much of the prestige of the business lies.

• Underwriting. The bank arranges new issues of shares and bonds in the primary market, including initial public offerings. In a firm-commitment deal it buys the securities and resells them, taking the risk of a price fall; see underwriting.
• Advisory. Bankers advise on takeovers, sales of businesses, defences against bids and restructurings, and are paid mainly when a deal completes.
• Sales and trading. Desks trade shares, bonds, currencies, commodities and derivatives for clients, acting as a market maker in the secondary market.
• Prime brokerage. Banks lend money and securities to hedge funds and hold their assets; see prime broker.
• Research and asset management. Analysts publish research on companies and markets, and many groups also run investment management arms.

Financing deals such as a leveraged buyout often combines several lines: advice, a bridge loan and then underwriting of high-yield bonds to refinance it.

Investment banking grew from merchant banks that financed trade and government loans, such as the London houses of Barings and Rothschild in the nineteenth century, and from US firms that sold railway and industrial securities. After the 1929 crash and bank failures, the US Banking Act of 1933, known as Glass-Steagall, separated deposit-taking banks from securities underwriting.

That separation eroded over decades and was largely repealed by the Gramm-Leach-Bliley Act of 1999, allowing groups such as Citigroup to combine both. In London the Big Bang of 1986 opened the stock market to outside ownership, and most British firms were bought by larger foreign banks. Deregulation, securitization and growth in derivatives made trading the largest source of revenue at many firms by the 2000s.

Stand-alone US investment banks financed themselves heavily with short-term borrowing, including repo, and held large positions in mortgage-linked securities such as collateralized debt obligations. In 2008 Bear Stearns was rescued through a sale to JPMorgan in March, Lehman Brothers filed for bankruptcy on 15 September, Merrill Lynch agreed to be sold to Bank of America, and Goldman Sachs and Morgan Stanley became bank holding companies supervised by the Federal Reserve. These events were central to the 2008 financial crisis.

Reforms followed. The Dodd-Frank Act of 2010 introduced the Volcker Rule limiting banks' proprietary trading, pushed standardized derivatives through central clearing and raised capital requirements alongside Basel III. The UK required large banks to ring-fence retail deposit-taking from investment banking from 2019. In 2023 the Swiss authorities arranged the takeover of Credit Suisse by UBS after a loss of confidence.

Critics argue that investment banks earn high fees and pay large bonuses while taxpayers bear the downside in a crisis, a form of moral hazard. Conflicts of interest are a recurring issue: the same group may advise a company, lend to it, trade its shares and publish research on it, which regulators address with information barriers and disclosure. Supporters reply that investment banks provide liquidity and make it possible for companies and governments to raise capital efficiently, and that post-2008 rules have made them far less leveraged.

• Financial Industry Regulatory Authority (FINRA)
• Federal Reserve: Volcker Rule