Differences Between Commercial Banks and Merchant Banks (Investment Banks)

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While commercial banks deal more with individuals as customers, investment banks cater more for the needs of firms. There are various differences in the conducting of business by both types of banks. Commercial banks take deposits and issue loans, while i

Commercial banks take deposits from customers, which may be individuals or corporate, and provide a payment transmission service, savings and loan facilities. They are allowed to accept deposits and create money through the credit multiplier. Investment banks are more in the business of helping corporations to get the required funds. It offers a range of services from corporate financing to loan arranging.

It can be said that the main difference between commercial banks and investment banking is that the former refers to deposit and lending activities while the latter relates to securities underwriting and other security-related activities.   

Banks such as HSBC or Deutsche Bank are referred to as commercial banks because their main business is deposit- and lending-related, although they both have substantial investment banking operations. Goldman Sachs and Morgan Stanley are known as investment banks because securities-related activity constitutes the bulk of their banking operations even though they also take wholesale deposits and lend.

In terms of services offered to large companies, commercial banks typically provide cash management, payments and credit facilities whereas investment banks arrange other types of financing through the issue of equity and debt to finance company expansion. They also offer an extensive array of other securities-related services including risk management products (such as interest rate and foreign exchange derivatives) and also advice on company merger and acquisitions activity as well as other company restructuring.

Further more, commercial banks are considered to be more risk-averse for the reason that they make money in a much diverse way than investment banks. Commercial banks generate profits from the spread between what they pay their customers for deposits and what interest rate they get from loaning out depositors’ money. Such banks are vested in the success of their customers given that if a loan is not paid back, the bank loses money. Moreover, commercial banks are under the close supervision of the Federal Deposit Insurance Corp., the Federal Reserve and the State Department of Financial Institutions, among other regulators.  Such oversight results in far less risk for Commercial Banks.

On the other hand, investment banks do not take federally backed consumer deposits which enable them to be less regulated than Commercial Banks. They are not under the scrutiny of many regulators. In fact Investment firms are overseen by just the Securities and Exchange Commission, which has also been criticized for its lack of careful oversight of the Investment banks. For this reason also, such banks offer products that have potentially high returns and high risk. Moreover, the future success or failure of clients is of lesser concern for investment banks because in providing their services, they receive upfront fees before actually doing the work.  

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Posted on Feb 5, 2012