Many people are interested in finding out how investment banks make their money because they seem to be able to pay their top executives huge bonuses. It seems that they must be doing something pretty amazing to be able to afford to do this. Therefore we investigate what these banks do and how they make their money.
What are Investment Banks?
An investment bank is not like a high street bank as they do not take in savings form borrowers and then lend them out as loans and mortgages. By doing this a high street bank makes money on the rate of interest they charge on the loans, which is higher than what they pay out to savers. However, an investment bank makes money by selling services. They sell to governments, companies and investment funds through hedge funds and fund managers. They charge fees and commission for doing this and therefore make money from these fees rather than through commission.
What do Investment Banks do?
They charge fees for giving advice. This could be telling a company how they can sell shares or how they can pay less in taxes, for example. The can organise finance deals for companies such as arranging the issue of shares, bonds and bank loans due to having good relationships with big investment funds. They employ traders to trade shares, currencies and other things for themselves and their clients. They have researchers which look into companies and industries and they sell this information.
Why do they make so much?
Each thing that they do depends on another and therefore if they have a good research team they can find the best investment funds. This will mean that businesses want to work with them and they will be able to cross sell their other services to them as well. This sort of work does generate large profits and this is why big investment banks make sure that they offer all of these services.
Why do they have a bad reputation?
People dislike these banks because they have been known to have been reckless with their trading in the past as well as with other activities. However, they do help companies find investors which should help the businesses to grow, create jobs and provide a wealthy economy which allows everyone to have the opportunities that they want. However, government regulation means that they are likely to shrink because they want them to hold onto more money to protect themselves against big losses. It is also more difficult for them to borrow money now as well. This means that it is less likely that they will be able to trade with borrowed money and therefore unable to make the big profits that we have seen in the past. The big profits and large bonuses are also something which tends to make them unpopular, particularly with customers who bank with them and feel that they are being charged money in order to pay for those bonuses. However, if these profits shrink then it is unlikely that those large bonuses will be something that they can afford to pay any more.