Commercial banks and investment banks are two of the main types of banks that serve different purposes in the banking system. With the deregulation in the 1980s and 1990s, the lines between them have blurred, but there remain some key differences between commercial and investment banking. This article will explain what commercial and investment banks are, their traditional roles, and the main differences between their business models and activities.
Commercial Banks Focus on Taking Deposits and Making Loans
Traditionally, commercial banks, also known as retail banks, focused on providing banking services to individuals and small businesses. Their main activities included taking deposits and providing loans and mortgages. They operated through local branch networks and offered basic financial products like checking and savings accounts, CDs, credit cards, and auto loans to the general public. The funds they loaned out came primarily from the deposits they took in.
Investment Banks Raise Capital for Corporations and Governments
Investment banks worked mostly with large corporations, governments, and institutional investors rather than the general public. Their main activities were helping companies and governments raise capital through issuing and selling securities like stocks and bonds. They also offered advisory services on activities like mergers and acquisitions. Investment banks made money through fees and commissions rather than loans.
Commercial Banking Relies on Interest Income, Investment Banking on Fees
The different business models of commercial and investment banks meant their primary revenue sources differed as well. For commercial banks, the bulk of revenue came from the interest earned by lending out deposits. Investment banks relied on fees earned for services like securities underwriting, advisory work, brokerage, etc. This fee-based income is more volatile than interest income.
Commercial Banks Take Deposits and Make Loans, Investment Banks Don’t
While commercial banks take deposits from consumers and businesses to lend out, investment banks do not take deposits or make loans. They rely on fees and trading revenue rather than lending out deposits. However, with deregulation, some investment banks now own commercial bank subsidiaries that do take deposits.
Scale and Geographic Reach Vary Greatly
Commercial banks tended to operate locally or regionally through extensive branch networks. Investment banks had a national and international presence, working with large multi-national corporations. While commercial banks focused on serving retail customers in one country, investment banks were more concentrated in major international financial centers.
In summary, while there is increasing convergence in modern banking, important distinctions remain between commercial banking and investment banking in terms of activities, customers, revenue sources, geographic scope, and regulatory oversight.