2. Investment Banks vs Commercial Banks (Retail)

hello friends welcome to this
investment-banking tutorial from wallstreetmojo in this short introductory program on investment banking overview you will learn about what are the key
roles and responsibilities of different functions within an investment bank say
for example what is research what is sales and trading division how do banks actually help in terms of raising capital for various companies
what are these jargons all about what is underwriting what is market making and let’s say why investment banking M&A activities are the core and heart
and soul of investment banking division and we will also try to answer questions
regarding what is restructuring and reorganization and how banks actually
help in terms of doing that so as you may have understood that you know I was
referring investment banks and banks as as one term now these two things are
kind of very confused lot our reason being that you know commercial banks
have different work altogether as well as you know when we talk about
Investment Banking they are kind of very different from each other so the first
thing that let us kind of understand is what is a commercial bank and how a
commercial bank differs from investment bank let us now look at what is a
commercial bank now commercial banks are in fact referred to sometimes as retail
banks okay and an example of a commercial bank or a retail bank could
be something like Barclays JPMorgan Chase Bank then we can also include HSBC and there would be whole list of you know commercial banks but the primary
question here is that what is a commercial bank and what is their
responsibilities how do they earn money so let me put it this way in a very very
crude way let’s assume that this is a commercial bank and you know there are two different set of parties which are involved think of
you and me you know when we have excess cash you know we kind of deposit that
money in 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 corporates as well or business guys
so essentially what we are saying is that the bank actually collects dollars
from these depositors so what does depositors get in return one is that the
money which has been deposited is safe and second what they earn is
something called a interest rate so let’s call this as interest on deposit
so let’s say if you have deposited $100 and the interest rate is 5% the bank at the end of one year will pay you not only $100 which is your initial amount but in your account you’ll also see a $5 which is corresponding to the interest payment so you’ll have $105 at the
end of one year if you deposit $100 in the bank now this is on one side where
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 the individuals but we may
also see up some parts of loans which are given to corporates so what we are
essentially saying is that Bank actually collects money from the depositors and
gives them gives to those guys who are in need of money so and what do they
charge so what is 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 on loans
and now 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 an 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 business
where they are giving loans and you know this is something like a low-risk kind
of business and it’s called as commercial or a retail bank so with this
understanding of a commercial bank let us now move forward so let us now look
at what is Investment Banking first and for most please note that Investment Banking is different from traditional or commercial
banking which we have earlier referred to so Investment Banking is do not take
you know deposits like the way traditional bank does neither do they actually pay our act like 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 so to understand Investment Banking better let me give
you an analogy with respect to a property broker now who is a property
broker let’s assume that on one side there are buyers buyers of apartment and
then on the other side there are sellers of the apartment so there are buyers as
well as sellers of the apartment now obviously they would like to transact
and make this market happen now on one side when the buyers who are individual
buyers are seeking these sellers you know sometimes or in fact many at times
it becomes very difficult for the buyers to do all the due diligence with respect
to the apartment or maybe you know look at the financial considerations and
negotiate them so and in addition the important thing is even searching is
also a problem for them so what happens is that these buyers may actually get in
touch with people called property brokers now these
property brokers will do a couple of tasks you know they would identify how
many sellers are there in the region you know they would communicate and kind of make a checklist on the legalities associated with the apartment they will
do the complete due diligence you know what are the financial considerations
and they search and depending on the requirement of the buyer they would kind
of suggest the properties so a property broker is someone in between who is
doing all these tasks now how do these property brokers normally make money
this is through Commission’s that they earn and commissions are primarily on
successful transactions so let’s say if a buyer has bought a flat from a seller
at $10 million so a certain percentage will actually be a part of the property
broker as Commission’s or fees so I mean this is how a property broker functions
now having understood in very little sense how a property broker functions
now think about our investment banker I’ll call an investment banker as a
financial broker so instead of property broker I’m calling this as financial
broker what his job is essentially is to make the buyers on one side and the
sellers meet somehow now I’ll just quickly change the definition of buyers
and sellers in this context because I’m talking about Investment Banking here
now think about company okay instead of a buyer or seller I am talking about a
company now this company let’s say this company’s name is ABC and they want to
raise funds, raise funds meaning that you know they have a requirement of
raising funds because they are going to invest in expand largely from a very small city to you know they want to have a global presence all together so
for that they require funds so obviously there are two approaches to doing that
one is that they can approach a bank and second is that they can raise equity from the market and we call that as an IPO so
doing an initial public offering you know they can raise money from the
markets so let’s assume that they don’t want to go to the bank of for raising
for the funds so the option that they are evaluating is through equity
dilution so what they mean is they are ready to give a share of their company
to certain investors who would be willing to do that why are initial public offering now if company ABC may want to kind of go ahead and do this initial public offering they will find it really tough because couple
of things would happen there are legalities associated with it then if
you talk about you know how to be aware of the processes you know they may not
even know that third at what valuations you know all these things they may not
be actually equipped to do that so what they essentially do is that you know
they contact someone called a investment banker and the role of the investment
banker is to do all these tasks, check at the legal options you know look
at the processes talk about the valuations and what this broker does is that he
identifies all the set of investors for this IPO so S would mean investors here
in this case and the investment bankers are sophisticated financial brokers in
fact that they are connected with the investors and they help these set of
companies raise funds and that they all understand the checklist of you know
raising through an IPO so this was a small example where you know investors
are on one side and the company is on the other side so how do the investment
bankers earn money investment bankers earn money by commissions like the way
you know the theory the property brokers used to on these guys actually earn
commissions on the amount of funds that are raised for this company ABC so this
is how investor banks actually earn money so do one of the ways you know
the other set of examples could be related to mergers and acquisitions so
let’s say there’s a company called ABC and they want to merge with another
company called DEF now the problem with these two set of companies would be that
they may not be equipped enough to handle all the regulatory aspects of the
merger as well as come to the appropriate calculations in terms of
valuations are prepared for financial models so what investment banking firm
does is they come in between and advise on the possibilities of the merger why
it should happen what are the possible synergies and in fact the key critical
aspects of investment banks is that the health largely with respect to
negotiating a price so you know if the price is high then you know how to talk
to the clients in order to make the two buyers and sellers meet at one point so
the expert negotiators as well so and and for that again they charge
Commission so a certain amount of Commission 1% 2% just as an example can be understood from the point of view of Investment Banking so in an actual think about a property broker and that the property brokers role is just to
kind of you know help the buyers and the sellers identify and in between property
brokers actually add a lot of value by helping the the buyer research as well
as the sellers also to identify the buyers so they are adding lot of
value in between so likewise investment banking also does the same while the
companies are looking for raising funds or you know they’re looking at mergers
and acquisition activities so investment banks do many other things as well so we
will discuss all of these in our following lectures I now hope that you
are able to kind of appreciate the difference between what is an investment
bank and what is a commercial bank

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8 thoughts on “2. Investment Banks vs Commercial Banks (Retail)

  1. Commercial banks /retail banks are as follows.
    ICICI and more plz correct.
    Investment banks are as follows.
    Golman sachs
    JPMorgan Morgan and more.

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