Dissimilarity between Commercial and Investment banks - Lorenzo V Tan

Lorenzo V Tan defined various helpful Dissimilarity between Commercial and Investment banks. “Investment banking primarily acts as broker between two entities who want to get into a financial arrangement like dealing in the purchase and sale of the stock, Mergers and Acquisitions, and helping in the initial public offer whereas the commercial banking provide the services with respect to the taking of deposits and giving loans to the individuals and companies.” In banking sector over 400,000 workers are employed around the country. At its simplest, the sector serves as the intermediary between those who supply financial capital and those who require it. It is broadly divided into two distinct divisions - commercial banking and investment banking, each of which provide markedly different services.

Commercial Banks

Commercial banks have two main functions; to accept deposits and give customers access to deposited money through checking or savings accounts, and to lend money to individuals and businesses. They are owned publicly or privately, or through a combination of both, and can be used by all residents.

Commercial banks make money through lending to customers, offering interest rates above what they pay to depositors. The difference between what the banks pay in interest and what they take in is called the ‘spread’ and is their main source of income. Lorenzo VTan defines Commercial banks are the most important part of the banking system as they provide financial services to the general public and are the type of bank people use most regularly.

Commercial bank and you know there are two different sets of parties that are involved. Think of you and me you know when we have access cash you know we kind of deposit that money in the bank. So we are essentially depositors, right? A bank is a place where they collect money from various depositors. So depositors can be in the form of individuals or they can be corporate as well; a business guy. So essentially what we are saying that the bank actually collects dollars from these depositors. So what does a depositor get in return? One is that the money which has been deposited is safe and second what they earned is something called an interest rate. So let’s call this as interest on the deposit. So if you have deposited $ 100 and the interest rate is 5 % the bank at end of one year will pay you not only $ 100 which is your initial amount but in your account, you will also see $ 5 which is corresponding to the interest payment. So you will have $ 105 at the end of one year if you deposit 100 $ in the bank. Now, this is one side where the bank actually sources money. The second is basically where they deploy the set of money. So think about you know loans. Loans in the form of you know home mortgage loans. You know they could be individuals who would like to have car loans, you know it could be personal loans; it could be any other format of loans. So this may be with respect to individuals but we may also see some parts of loans that are given to corporate. So what we are essentially saying is that the bank actually collects money from the depositors and gives to those guys who are in need of money. So what do they charge for the benefit of the bank here? The benefit of the bank is that they earn again interest which we will call that as let’s assume unknowns and you know this is their interest income and this is their interest expense. So the bank actually earns money by ensuring that the interest on loans that they earn is greater than the interest on the deposits that they give. So this is interest income and on the other side, this is an expense. So if a bank is able to manage this; the bank will be profitable. So traditionally the banks have been doing this kind of a business where they are giving loans and you know this is something like a low-risk kind of a business and it’s called a commercial or retail bank.

Investment Banks 

Investment banks perform complex financial transactions, linking big businesses with investors to raise capital for companies and governments. They assist governments and businesses in issuing securities and selling to investors, help investors safely invest their capital in bonds, stocks etc. and provide advisory services. They offer customer specific service and their performance is directly related to the performance of the financial market. There are three primary functions of investment banks; corporate finance, wealth management for private clients and capital markets. 

Lorenzo V Tan says that Investment banks earn income by charging fees for their services, and commissions on trading activities and the sale of securities. They are generally privately owned. They have external clients and trade their own accounts, which mean a conflict of interest could occur if trading and advisory divisions are not independent. Clients of investment banks can include financial institutions such as pension and superannuation funds, governments, and companies.

Investment banking doesn’t take your deposits as the way bank does. Neither do they actually pay our act as a guarantee for safekeeping the money of the depositors? So investment banks do not do that. So let’s see what investment banks actually do?

Types of Investment Banks 

There are broadly two types of investment banks in terms of size, scope and presence:

• Full-service – These banks offer the full banquet of available investment services to potential clients, such as underwriting, trading, merger and acquisitions, securities services, merchant banking, and investment management. This might be the sort of bank for you if you’re keen to dip your toe into lots of areas in the world of investment banking.
• Boutique – These investment banks specialize in particular activities, such as advisory services for a specific region, and focus on mid-market deals. If you’re more in favors of specializing, boutique banks might be more up your alley. These investment banks will have expertise in one or two specific fields of work or focus their advice and expertise on a more specific geographic area.