Commercial Banks and Investment Banks Essay
This paper focuses on the research about the difference between commercial and investment banks. There might have been several studies done in the past to prove the working, structure, determinants and the goods and bad of both sort of banking system but this paper specifically focuses the distinction between the working of investment and commercial banks, the distinction between them and if there is really some distinction is it getting less or not? The hypothesis of this paper is that the distinction between these two financial institutions is getting less day by day. We apply our framework to provide logic for analysis of the industry, to examine the consequences of global competition and discuss the effect of the differences on the economy by the two institutions.
First of all I would like to thank God for making me able to complete this course. Secondly I would like to thank all my teachers who help me throughout my studies, to clear my concepts and to guide me where ever I ask help. Without their help and guidance it would not be possible for me to complete my project. I would also like to thank my parents for all their support they gave
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The banking system started from the very ancient times in history. The early bankers were merchants or moneylenders. With the passage of time the banking system was categorized into various branches termed as:
v Central bank
v Commercial banks
v Industrial banks
v Agriculture Banks
v Exchange Banks
v Saving Banks
All of these banks have their particular contribution in economy as well as society. However the scope of this paper is limited to the study of Commercial banks and Investment banks. This research paper mainly focus on the differences or similarities between commercial banks and investment banks, and it is to be proved weather these two organizations are getting closer in their functions and services.
Commercial Banks VS Investment Banks:
Commercial banks are usually termed as the bank of common people or in general terms this is the main bank used for the transactions by everyone. This bank is responsible for accepting deposits of customers as savings and to create credits for the investors, individuals or businesspersons. While in the same economic system there exists an Investment bank. Investment bank has a major responsibility of creating market for the selling and buying of securities, financial assistance to its clients for the investment purposes and the privatization of Government property by selling its shares publicly.
What we get from research:
By the research we did in this it was cleared to us that the commercial banks are to a major extent doing the same job as the investment banks. There might be difference between the ways of performing the task but the bottom line is that ultimately the goal is to create credit and to mobilize investment.
In this paper we try to get the insight of the topic ‘Commercial banks’ and ‘Investment banks’, their functions, their similarities, dissimilarities, the growing trend which is bringing them closer in services etc. All this research is done through pictures, literature, graphs, definition and maximum collection of data although through primary data. An analysis was done after performing the research through books, internet, articles as well as the personal point of view which can be observed at various places in this paper. The paper falls into many categories, chapters and headings to make it more easily understandable and readable.
Is the difference getting less?
There are a number of studies previously done and still going on regarding the topic, while this research particularly focuses on such journals, articles and sources where we find the evidences relating to the decreasing difference between the investment banks and the commercial banks. On searching it has been proved to an extent that in developing countries like US the commercial and investment banks have been working together again since the start of new millennium, before that in 1933 according to the Glass-Steagall Act they were separated in their working and transactions. A brief literature review was conducted to place this study with regard to the previously done research as well as the upcoming debates and concepts. The literature review falls into various categories and sub-headings which explain the topic in detail through definitions, concepts, pictures, graphs, tables etc.
The Core literature and findings from the study:
The study reveals the fact that the commercial banks create credit to lend the money by the deposits it gets from people, however the investment banks create funds to provide services to one firm by the means of some other, this is done to selling bonds n shares hence it is a connecting bridge between two firms. Hence the main aim is to provide credit. Although it is known that larger organization mostly go to investment banks for fund raising, but still commercial banks provide loans not only to individuals but organizations as well. In the present time commercial banks are expanding themselves to work equivalently and to maximize the credit structure so as to fulfill the requirement of the larger organizations or bigger projects. The paper has also discussed the various countries, their banking systems and the contemporary situation in their business world. The cheap lending of loans by the universal banks have made their place prominent in the banking industry. In the upcoming years the results will prove this hypothesis more precisely and clearly that the difference between these two organizations has become so less. If it will be fruitful most probably they will work neck to neck with each other and will provide maximum support and services to its clients.
Chapter #1: Introduction
Chapter #2: Literature Review
2.1 Commercial banks:
2.1 Functions of Commercial Banks
2.2 The creation of credit
2.3 How bank create credits:
Chapter #3: Investment banks
3.1 Functions of investment banks
3.2 Who actually needs an investment bank
3.3 Measuring the size of investment bank:
3.4 Credit creation by investment banks
3.5 Directive of policies and implications
3.6 Investment banks in developing and changing economies
3.7 The role of investment bank in the common stock IPO
Chapter #4: The differences and similarities between Commercial banks and Investment banks
4.1 The similarities
Chapter #5: Discussion
5.1 The Difference is getting less
5.2 Proves and theories:
5.3 Comparison in working:
5.4 Bonds system comparing with the Credit system
5.5 A look at the history
5.6 The merging of commercial and investment banks in US
5.7 Who takes more risk?
5.8 Who makes more money?
5.9 The contemporary situation
Chapter #6: Conclusion
Chapter #7: Methodology
Chapter #8.: Limitations
Chapter #9: Recommendations
A bank is: “A financial institution that is licensed to deal with money and its substitutes by accepting time and demand deposits, making loans, and investing in securities. The bank generates profits from the difference in the interest rates charged and paid” (ADVFN 1/13/05) OR
“A bank is an institute which deals in money. Broadly speaking banks draw surplus money from the people who are not using it at the time, and lend to those who are in a position to use it for productive purposes” (Dewett, n.d).
The bank at the present time has their ancestors from merchants, goldsmiths and money-lender. Money can be described in two ways flat money which can be piled and round money which can be circulated.
A bank is a financial institute operates in such a way that people keep their money and valuable assets with it. A bank has no product of its own except revolving money between those who have surplus income, and those who have income deficit. The surplus and deficit can be of any sort, may it be the household budget, or the business expenditures, or the newer investment to be made. The bank is the centre point for every one requires money or owning extra money to save with the bank or to lend from the bank. Banks play a very vital role in economic development. The major types of account anyone can open in a bank are savings accounts, checking accounts, money market deposit accounts (MMDAs) and certificates of deposit (CDs) etc. While opening an account with a bank one must keep in mind, interest rates, convenience, FDIC membership, size, and minimum deposit. Compare services like direct deposit, ATMs, online banking, credit cards and debit cards. With the passage of time and advancement the banks have offered several facilities to its customers like ATM, Credit card billing system, easy car finance, and home finance as well as online banking system to pay bills and shop. According to their specifications and specialization banks can be of following types:
o Commercial banks
o Industrial banks
o Agriculture Banks
o Exchange Banks
o Saving Banks
o Central banks
This paper mainly concerned with the two financial institutions, Commercial Banks and Investment Banks. The aim of this study is to get insight into these two organizations and find out the similarities and differences between them also to draw a conclusion whether our hypothesis is right or wrong. The research question for this study is: Is there a distinction between Commercial and Investment Banks? If so, is this distinction getting less? And the hypothesis is: The distinction between commercial and Investment banks are getting less.
Let us take a broad view of these terms in detail in the literature review. (Dewett, p.483, n.d)
2. Literature Review:
The goals of this paper are it enumerates the relationship between the commercial and investment banks, and to determine the differences or similarities exist between them. If there are any differences, are these differences getting less or not? In the following section we review data and conjectures from the literature regarding the above mentioned questions. Much of the literature in this paper has discussed the evidences of the similarities and dissimilarities between these two financial organizations; also the major emphasis is on the argument about decreasing difference. Some research and studies done regarding to the topic has also shown that the merging of investment and commercial banks and the insurance companies in US after a long period of separation has shown remarkable changes in the business and banking industry. Also we find a number of papers written against the merging of these institutions and showing a bad impact on the business cycle due to it. We did a bank-level analysis to study the behavior of these two organizations and were particularly interested to reach the situation where the conclusions regarding the topic can be made.
2.1. Commercial banks: “These are chiefly engaged in financing internal trade and also carry on other ordinary banking business of receiving deposits, advancing loans discounting bills etc. (Dewett, p. 483, n.d)
Commercial banks perform an intermediate action between those who have extra money or facing surplus in their expenditures and those who are facing deficit. The two main functions of any commercial bank are to receive deposit and to advance loans. Basically a commercial bank borrows money to lend it to others. For example a person running a business facing a decline in profit or the revenue is less than the expenditures therefore such a situation make him fall in the deficit position and hence to overcome such a deficit the person can freely look toward any commercial bank. Similarly the credit billing system have made it easier for an individual to pay bills , to shop or dine out anytime and all these offers and packages are made by commercial banks. (Dewett, p. 483, n.d)
2.2 Functions of Commercial Banks: There are a number of functions performed by commercial banks they are categorized in the following four ways:
o Deposits Management: Commercial banks are responsible to keep the surplus money of the people as deposits. The bank do it in many ways like:
I. Demand deposit, demand deposit is such a way of keeping money with banks that a person can anytime ask for his/her reserves from the bank. Since the bank does not get any sufficient amount of reserve against it therefore no interest is paid on it, except to those who keep larger balances with the bank. While a small charge is taken for the bank’s service provided to keep that money.
II. The other form of deposit includes fixed deposit. The fixed deposit are kind of deposits made for a particular time and only after the expiry of that specified date that money can be withdrawn. Fixed deposit is rewarded with higher interest payments.
III. There is a central point between fixed deposits and demand deposits, these are saving bank deposits. (Dewett, p.483, n.d)
o Grants of Loans: keeping deposits is not the only job a commercial bank does, but also to lend money to the needy is something a bank does. This is due to the reason that bank has to pay interest on the deposited money. A commercial bank has no product of its own but just the money which it revolves between the depositors and creditors. Commercial banks usually grant loans to the business men and traders for short span of time. Loans are handled by the advancement department in many ways like,
I. The process of over drafting is a way that the depositor can get more money than he/she has deposited with the banks. The interest is paid on the extra money taken. The cash-credit way of handling loan is also frequently applied in commercial banks. This is another way of lending money by the banks. In order to have loan the borrower have to keep something a security measure with the bank this may be anything which has market value like Government securities, property papers, bonds etc. the depositor hardly ever takes all the cash usually he/she opens a account with the bank and take the required money while keeping the rest with the bank. Therefore it is said that” every loan creates a deposit”.
II. The lender can also take money from the bank by having the discount in bills. The bill broker sell these bills to the banks and the bank give direct discounts to the merchants or the companies. The investment in bills is quite safe.
III. There are a number of functions besides these major functions which a commercial bank do like keeping valuable things, ornaments and important documents in the bank lockers so as to avoid them from being theft. The commercial banks also perform agency functions. Also they give references about the financial positions of their customers while the customer has to build relations with new firms inside or outside of the country. Commercial banks provide letter of credit to their customers when they are leaving for abroad. In that letter the local bank mention that the person can get money up to certain extent from the banks in other country and hence the bank abroad make payments to this person and debt the bank which has issued letter of credit. (Dewett, p.483, n.d)
IV. An appropriate and proficient banking system is required to run the economy in a better way. A country whose banking system is efficient is stable economically as well. Commercial banks serve the society and the country in much way. They create credits which is a best and most appropriate substitute of money. It promotes saving. It is the commercial bank which unites the borrower and the lender, and benefits both. Since the money from lenders is given to borrowers and this way it’s a great way of revolving idle money to productive usage. Saving can only be done effectively and easily by keeping the money with bank. Until the money is in hand it can never be saved and spend irrelevantly, therefore once its kept with the bank its far from the easy approach of pocket and home and saved for rainy day or longer period of time. (Dewett, p.484-485, n.d)
(ECONOMISTS VIEW, March 07)
2.3 The creation of credit:
The creation of credit is most important task done by commercial banks. It can be also referred as a programmed factory of credit. It is very clear to everyone that bank do not keep reserves for the deposits it holds in order to fulfill the customer’s demand, neither it is a money box where u put your and notes and get them at any time. It is obvious that the money some one deposits has to be advanced to some one else. Hence it’s just a promise or undertaking given by bank to its customer that the money will be returned whenever demanded. It is not necessary that the deposits are made simultaneously, if some one deposits other will withdraw the money at the same time, hence the bank creates a vast setup of credits so as to keep a portion of reserves in the form of interest and to fulfill the demand of the withdrawers at the same time. In the same manner the bank buys securities and against them it pays the sellers. It’s not a cash form its just a promise to pay cash. The bank deposits the cheque’ and creates credit for the seller of the security. This whole process is called credit creation.
2.4 How bank create credits: There are two ways in which a bank creates credit:
a) by advancing loans
b) by purchasing securities
In both of these mentioned processes the credit and deposits are created. On the whole bank keeps a very small reserve to itself, to run the organizational management and to maintain the banking cycle. Besides all these procedures of credit creation its benefits and cycle there are some limitations of credits creation as well. The banks usually advance loans and buy the securities without any payment of cash. One might think that its very exciting job this way the banks can produce maximum profit. At a certain point banks has to put a stop which is in their own interest as well, since it is known that the profit made by banks is not too high. The limitations on the authorities of the bank to create credit can be in three ways: i) the cash in the country totally there at the current time ii) the cash to be kept by the public which they really want to keep iii) the percentage of cash to deposit with the bank which the bank consider safe. The necessary conditions for creation of credit are that the banks should get cash to be hold by the depositors, the borrowers should be willing to lend and the reserve that are withheld should not be withdrawn so frequently but should be stayed for a period of time. The deposits that the bank creates are done through the money which is still with the bank i.e. not withdrawn. (Dewett, p.486-487, n.d)
On the whole it is clear that the first objective of any commercial bank is to maximize profit for its share holder. The second is to obey the rules and regulation as set by the e central bank and other regulatory bodies. Third is to use the marketing strategy to increase the business and look for newer ways to have bigger profit. Fourth is the customer service issue which has been deserted in recent years, but some banks are trying to deal with this matter. However the role of commercial banks is vaster than any bank.
1) To issue notes,
2) To process payments from any means like telegraph, internet banking or mail.
3) To issue bank drafts and bank cheques.
4) To accept the money in terms of deposits
5) To lend money in the form of loans
6) Keeping in safe documents and other valuable assets in the lockers
7) Currency exchange etc
Now let us have a look on the second major type of banks to be discussed in this paper, which is investment bank.
3. Investment banks: “Financial institutions that help corporations issue stocks and bonds in order to raise money. Unlike regular banks, they do not accept deposits or make loans”. (Teen Analyst Advice, n.d)
An investment bank is like some individual or institution which works like an underwriter or agent for firms and municipalities for the handling of securities. Mostly investment banks perform broker/dealer operations, maintain markets for already issued securities and provide suggestions to investors. They also play a vital role in raising capital, and the restructuring of firms. They are not responsible for providing loans and deposit money from individuals. (Graham and Hamilton, n.p, August)
3.1 Functions of investment banks: any investment bank is responsible to perform the four major functions: formation or increase in capital, it gives suggestions in the combining of two or more companies into a single corporation, and savings made by the millionaires, managing securities and trading and sales, and giving advices to the investors. Most big investment banks perform all of these functions while smaller banks are able to do two or three of them. We will discuss each of these terms in detail:
o Capital formation: An investment bank help and guide the investor to raise funds in order to attain a number of goals, such as : to expand the existing firm, to cut down the debt stack, for financing some projects, or for the purchase of new company or plant etc. the investment bank take such measures to create financial help and advice for the client in order to frame the dealings and all procedure as well as offering attractive packages to do business.
o Combining of two firms and acquisition: the merging, acquisition and diversifying of the firm are some of the matters handled by the investment banks. For example a the acquisition of some firm, some company which is going to be sold or subsidized, in all of the above cases the investment bank perform the key role in buying or selling procedures.
o Trading and sale services: the services of sale and trading provided by the investment bank are specified to the firms which are trading openly. These specific functions include to create market in stock, prepare new offers and to issue the research reports.
o Suggestions and guidelines: the suggestions and guidelines function includes the making of strategies, the financial assisting help for the renewal or restructuring the framework of any business, and several other such business activities.
After discussing the functions and definition of investment bank it is of equal importance to know who actually need an investment bank?
3.2 Who actually needs an investment bank: Any firm which is expecting a fair and proper business can get assistance from the investment bank. . (Graham and Hamilton, n.p, August)
(Corporate and investment banks, n.d)
Although large firms have their financial assistance departments but still an investment bank provides some clear objective, a sophisticated association of acquaintances, appreciates the proper use of the client’s personnel and is much interested in letting the deal done perfectly. However in small and medium firms there is no financial assistance department to deal with the transactions made therefore it may be possible that any new deal specially with larger firms and corporate may result in a disadvantage or loss to the small firm. Hence an investment bank can perform the role of instructor to help in making the transaction successful and in great benefit to both parties. (Graham and Hamilton, n.p, August)
Investment banks works as a connecting bridge between the corporate and the investors who have money to purchase securities and to invest for certain business purposes. The investment bank generates its revenues by the fee it charges for the financial assistance is provides to its clients. The entire working of any investment bank depends on the law and regulatory system of the country where the bank is situated. For example in US, Japan, and UK investment banks are referred as the trading companies run publicly, and are independent. While in the rest of the world investment banks are usually part of larger firms and financial organizations and work as investment and commercial banks as well as insurance issues in some cases. (Investment banks, p23, n.d)
(Investment banks: Key Characteristics of Investment Banks p23, n.d)
3.3 Measuring the size of investment bank:
There are many ways of measuring the size of the investment bank. They can include the assets the bank posses presently, the number deals within its hands and done, and the total profit it earned. The top investment banks of the world are Morgan Stanley Dean Witter and
Co., Credit Suisse First Boston, Citigroup, Merrill Lynch, and Goldman Sachs in the United States, and Nomura Securities in Japan. Another key feature of the investment is to sell the bonds issued by the central bank, it is common practice for the developing countries that to finance their big projects the Government sell securities in term of bonds which a promise done by Government to pay against it anytime required, this is done mostly through the investment banks. (Investment banks, p23, n.d)
(Investment Banks: Investment bank diagram p26 n.d)
The term investment banking is usually misunderstood as it is investment in the banking field. It is mainly one of the many functions performed by the banks. Investment banks buy and sell products for its clients as well as for itself. The risk factor in investment banks field is proprietary trading. The banking industry is capable of increasing its profitability by taking maximum risk. The whole business of money cycling is risky and hence it is done under the expertise to tackle such tasks. Investment banking is the worldwide working industries, and is experiencing diversifying challenges day-to-day. The question which is much important to discuss here under the discussion of investment banking as it has been discussed under commercial banking chapter is hoe do investment banks create credit and why?
3.4 Credit creation by investment banks: There can be many ways to define the term creation of credit by investment banks with reference to the business cycles, monetary policies and research terminologies. Money which circulates continuously can be considered in either ways either the present good or the future good; this may be termed as the most frequent flow of money.
“It is only in this relative sense that the money rate of interest is of significance in regard to movements of prices. It can at once be seen that it is quite useless to try to demonstrate the existence of any direct relation between the absolute movements of the rate of interest or of the discount rate and movement of prices”. Cochran and Call, p39, 2000 (Wicksell, 1965, p. 107)
Money if not spend is hoarded and if not hoarded then spent on irrelevant things. With the passage of time the monetary value of the commodities get less and the value of the currency or resell value of the commodity is far less than the money actually spent. What to do in such a situation? Definitely by investing it or saving that amount will last longer and gives better benefits to the saver. This is major approach of banking system to promote saving and investment and to keep a bit portion for itself in order to circulate the money in the market. The creation of credit happens in the same way. Money or credit is created as bank make loans. There are many exogenous variables in the economy which have direct or indirect effect on the creation of credit. Let’s say the rate of interest from the central bank. If it is raised all the banks have to follow this rate and hence the borrowing decline. Since now the borrowers have to pay higher rate of interest on the credits, while if this rate is declined the borrowers and investors are encouraged to take money and hence the bank business done with greater speed and prosperity. (Cochran and Call 2000)
3.5 Directive of policies and implications: in US and many other developed countries the main director for the investment banks performance is the SEC (security exchange commission). It is mostly decided by SEC that how much information and data must be revealed about the firms which are in the trading cycle. Therefore the investment bank is abided by the rules set by the SEC to be careful in disclosing and collecting information about these companies.
3.6 Investment banks in developing and changing economies: In diversifying and developing economies the investment banks plays vital role, as they work for Government in privatizing its certain organizations and industries. The privatization deal means that Government asks offers for its industries, plants like electric plant, water plant, and some manufacturing plants to be purchased or taken share by the public as an IPO. For this purpose Government asks for the investment banks’ services to make market for, advertise and start campaign for the sell of any such property and to attract domestic and inter-national private investors. (Investment banks, p24, n.d)
In most developing and changing economies the working of any investment bank is dominated by the foreign banks, and private sector branches of a big organization like World Bank Group’s , International finance group (IFC). The countries which have outfitted stock markets, IPO’s usually functions there. (Investment banks, p24, n.d)
3.7 The role of investment bank in the common stock IPO: When a company is sell to the general public for the first time. IPO’s are selected by the corporate clients who are interested to sell their stock publicly. While the process of IPO the CFO (Chief financial officer) propose the interest of the corporate client. Generally the CFO appoints an investment bank for the assistance and guidance which is equally important like any other matter of selling procedure. The deal manager is the person whose job is to analyze the position of the client and the market so that the sell must be done efficiently and professionally. Then there is a deal team which designs the prospectus or brochures showing the criteria the features and the detail information of the offer. The deal manager is responsible to consider the following question during the deal process:
Ø When the company will be sold publicly what will be the tax laws? And how will they affect the company?
Ø If the company has any site infectivity, does it need to be revealed?
Ø The suitable time to be selected is important, is the time right for an IPO?
Ø After this whole procedure the following events take place readily:
Ø The analysts who are hired to handle the sell frequently decide the demanded price of the IPO shares to the market. (Investment banks, p24, n.d)
Ø The marketing for the sell takes speed. The representative of the deal team meets the potential investors and interested buyers.
Ø Lastly the openings of purchase to the interested buyers are made on some specified day by the deal team and the corporate owners. The stocks and shares are announced to be sold publicly. (Investment banks, p24, n.d)
4. The differences and similarities between Commercial banks and Investment banks: After quite a long review from the definition, working, functions till the key characteristics of the commercial and investment banks, now we will discuss the similarities and differences between them in order to prove the hypothesis drawn for this research study.
4.1 The similarities:
o In general ‘commercial banking’ procedures starts from very simple steps.
This is a simple cycle or the money circulation by a typical commercial bank. This cycle starts with the consumer depositing their money as saving with the banks or businesses depositing the large sum of payments to banks, the bank keep a certain portion as security so as to fulfill the sudden requirement if some one deposits his/her money readily or to pay for possible loan defaults and circulates the rest of the money to the companies or organizations who need to pay for raising capital, plant extension etc. the second most important point to be considered and compared between both types of financial organizations is how do they make money to maintain themselves? Well, the answer to this question is so simple; the circulation cycle includes the lending of money as well as the depositing of the money. The lending of money say is on 12-14% of interest while the depositors are paid 8-9% interest on their savings. Hence the remaining portion is bank’s profit, this way the commercial bank run themselves. (College Journal, n.d)
o The ‘investment banks’, on the other hand, includes the activities such as underwriting, selling securities like bonds, providing financial assistance and asset management. 9investment banks mainly do the tasks like,
I) Lending, investing and selling bank’s assets
II) Trading of securities like bonds etc
III) Providing assistance and guidance to firms while they are merging or expanding themselves.
IV) Provide connection between two firms where one is expanding and other is investing as a share holder in it
V) Selling of Government properties publicly and making arrangements for it.
VI) Maintain a list of investors domestically and overseas clients.
Hence both the financial institutions have certain similarities which can better be studied in the following way:
Commercial Banks Investment Banks
Retail loans to companies financial services to companies and larger organizations. for raising capital and,
Lend money at interest rates
Take money as consultancy charges
From the figure above we can take look on the transactions or working as well as the making of money to run itself by both the banks. We can say that the terminologies can be different but still by changing words meaning doesn’t changes. A bank in general is a place to keep money or to get money as loan from. To stand in the business market it needs some finance for itself and that is drawn by the interest charge or the consultancy or service charges by clients. (Investment Banking, n.p, n.d)
4.2 Dissimilarities: where there are similarities there can be few dissimilarities between the two types of banks as well :
o The client of any commercial bank can be from the owner of some barber shop to the multinational owner or industrialist. For very large sum of loan several commercial banks merge together in order to arrange the amount termed as ‘syndicated loans’.
o Investment bank, on contrary provides services to large firms, industries, businessperson more precisely- companies, Government, on-profit institutions and well-off individuals.
o Commercial banks have lower risk tolerance as compare to the investment banks.( College Journal, n.d)
5.1 The Difference is getting less: The discussion is now turning towards the basic aim of this paper, which requires the hypothesis to be proved that, if there is some difference between these two kinds of banks, is the difference between these two organizations getting less?
My hypothesis in this paper is that the difference if so exists between these two banks is getting less day by day. We discussed the similarities and dissimilarities a few, but now we will take a deep insight of the similar working and the core matches between them to prove our hypothesis. Let us start from the question what is investment banking or simply i-banking, is that a bank, some investment institutions, is it banking or investing in real. The answer is so simple that an investment bank creates funds or raise capital for larger organizations and companies, for these companies capital means money in general. To let the decision to be taken by the reader after reading the literature that really these two organizations are quite similar and getting similar gradually, we will also explain a bit of function by the commercial banking system, in order to compare them and to draw our final conclusions after proving the hypothesis.
5.2 Proves and theories:
Although commercial banks and investment banks are similar in many ways but still they have some differences as well. The differences between them were removed after the Gramm-Leach-Bliley Financial Services Modernization Act of 1999 was declared, but somehow as we have discussed the details of working and functions of the two banks in this paper, therefore we will use to examine the similarities. As we know that the rules and laws have changed the business paths on which these two organizations may travel but the after taking in-depth view of the working one must say that the main functions is still the same. (Chapter 1: What is an Investment Bank? p1, n.d)
5.3 Comparison in working:
A commercial bank typically, takes deposits and saving from the consumers, the Government provides insurance of these securities which is legalized by the FDIC , which is given on amount $100,000 and in order to get the FDIC guarantee every commercial bank must have to follow the rules designed by the FDIC. The commercial bank has a simple function, to takle deposits from the consumer and circulates it in form of credit to others. One can take loan to finance home, car, shop, or to raise funds for expanding the existing business etc. Companies that usually take loan from the commercial banks has no limitation in size and wealth, they can be from smallest to bigger businesses. It is very important to know here that the loans from the commercial banks are the direct link between the consumer and the bank or the company and the bank. Commercial banks have a direct personal linkage between them and their clients. The terms of loans and the amount as well as interest to be paid by the client is negotiated by keeping in eye the credit history of the client, lets say you have to draw $200,000 for 5 years for home financing, all this is done by the relationship between customer and the bank. (Commercial Banks Falter, p3, n.d)
An investment bank on the other hand is the second important branch of the banking family. It operates differently but the output is almost the same. An investment bank doesn’t hold a sum of money deposits from clients to lend as commercial bank does, but an investment bank works as a connecting path between the sellers of stocks and bonds and buyers of stocks and bonds. However it is notable here that the companies communicate with the investment bank in the same way as they communicate with the commercial banks. Since the reasoning is same just the method to be applied is a bit different. When a company needs funds it can see towards a commercial bank or it can ask an investment bank to sell equity or debts (Chapter 1: What is an Investment Bank? p3, n.d)
5.4 Bonds system comparing with the Credit system:
Let us take a look on comparing now the bond system in investment banks or the credit system in the commercial banks. Suppose some company named Acme needs some amount of $200 million. This company can raise the fund from some commercial bank against interest payment, like any individual do from the same bank on interest payments. Or the second method this bank can use is to sell its shares in the marketing form of bonds, this selling is open for everyone. People buy these bonds which is a legal promise that anytime they will be sold money will be paid to them. Also the investment bank is abided to pay a bit of interest from its earnings to the buyers. This way the bank performed a function of attracting buyers to purchase the bonds and the loan money is generated from several individual buyers instead pf the investment bank directly. In all this procedure the investment bank get its share by charging the company a bit amount after the completion of loan grant project. Just like the commercial bank charge a certain amount of interest to be paid by its creditors after the grant of loan and this way they get the money to be lend. (Commercial Banks Falter, p3, n.d)
(What is an investment bank? p13, n.d)
5.5 A look at the history:
From the patches of the history we came to know that after the passage of the Glass-Seagull Act 1999, which was declared due to the crash of stock market in 1929 in which commercial banks were almost collapsed, it was decided by the Government of US that the two organizations must be working separately i.e. the commercial banks will be engaged in the banking activities like accepting deposits, crediting etc while the investment banks will be focusing on companies and will be limited to the capital market activities. However this difference is now getting less and not mandatory. (Chapter 1: What is an Investment Bank? p4, n.d)
5.6 The merging of Commercial and Investment Banks in U.S:
After 70 years since the Glass Steagell Act which was passed in 1933, to separate commercial and investment banks, the Gramm-Leach-Bliley Act, passed on March 11, 2000. According to this new act the older theories of separate commercial and investment banking working were again merged up and the commercial banks were given the rights to underwrite and sell securities just like any investment bank do. This can be referred as a new era of banking for the US banking industry. This law not only eradicates gaps between commercial and investment banks but also, it creates linkage between commercial banks and insurance firms. The removal of the wall between these two financial organizations the customers has got one place to fulfill all needs. From buying securities to insurance and loan issues one bank can help you out, the merging of these banks help in better performance as well as the competition between the financial companies, lower prices and availability of all services.
The economists and expertise analyst of today deny that the failure of commercial and investment banks working together has some issues which were discussed in the 1930’s, the reasons might be liquidity or insolvency and not mismanagement sort of things. One might think here that whether the merging of commercial and investment banks can cause insecurity for the business which each is doing. Let’s say by giving permission to commercial banks for financial assistance and investment banks to promote securities at a large scale can minimize their business transactions. But, still there is some limitation and ways to stay efficient in business. For example if a commercial banks although providing assistance in financial transactions to its customers, failed to satisfy them by smart decisions and fruitful results or the clients are not satisfy and feeling the services to be dishonest they will eventually move to the other bank. So in order to stand strong the banks needs to be good in all transactions and services or they will loose customers. The merging of the banks and insurance companies allow them to perform all the functions each one is supposed to do in the past. This help in the expansion of the financial institutions and to perform various tasks at a time. (Zaretsky, 2000)
5.7 Who takes more risk?:
Trading and dealers of the commercial or investment banks may be quite similar but banks accounts are different in a sense how these dealers make the most business out of it. Analysts say that the investment banks are larger risk bearers than the commercial banks. Although the merging have given both them equal rights in the US economy as well, but still there are terms which make them work distinctly from each other. This difference is mainly in terms of business done. Investment banks have to keep an eye all time on the market structure, before leaving for home they should be aware of the latest stock situation and their securities position. Commercial banks on the other hand have more accounting classes and categories of account to go for. This means that the chances of recovery in times of any failure are greater than those of any investment bank.
5.8 Who makes more money?
In terms of money investment banks are leading than commercial banks. They make more revenues and dollars than those of a well maintained commercial bank. A commercial bank in general has got the one-tenth value of the total revenue earned by the investment banks normally. However in times of negative development or profit commercial banks stand strong to fight back although the investment banks can’t. (Liz Moyer, 2006)
5.9 The contemporary situation:
The amalgamation of commercial and investment banks into a so called universal institution has made these organizations to utilize their cheap dollars to perform all the investment banking deals easily. What happen on true grounds that banks now being combined use the different companies’ shares to raise the fund, if this fundraising faces failure it is the organizations which bear the loss and not the bank in any way. However in many cases the raising of funds brings success and progress for the company. On the other hand it is also been said that as these two organizations are binding ties in every way the smaller financial institutions are at a greater risk, that now they might need to exit from business or need to expand themselves in terms of capital and fund raising which is not possible in the short run. (Moiseiwitsch, 2003)
Not only the banks in US are performing functions by merging with each other the banks in Malaysia, Korea and other parts of the world are raising their ties as well. Malaysian banks are coping with the upcoming challenges of the modernized banking era, by increasing their sales, insurance services and other financial businesses. Banks in the contemporary world use cheap loans in order to stand in strong position in all the banking transactions. The growing trend of cut-rate loans has been observed in the Korean region mainly. The Korean bank signed a US$ 400 million loan on September, 19 2002.
Now after few years it is observed again that the commercial banks are expanding themselves in order to entertain larger loans to the big investors, and organizations which will gradually eradicate the differences between the purpose, working and facilitation provided by the two organizations. (Chapter 1: What is an Investment Bank? p4, n.d) There can be a number of studies which have earlier discussed the commercial banks VS investment banks procedures. However the main idea of this paper is prove the hypothesis that the difference between them is getting less. This we have proved by taking several examples, figures, charts, definitions, as well as theories and literature.
May it be the credit creation to the selling of bonds and shares, or interest payments or fee charge against assistance, all these procedures have something in common and the input might be any, the path can be numerous but the output and the destination is still the same; to raise funds for capital or to create credit. We have taken an in-depth of the topic and have come to the concluding remarks. The working of the commercial banks and the investment banks is quite similar, and is getting closer day by day as the both institutions are putting modernization in them. Hence we proved by the thorough and detailed literature review done above that the difference between the commercial and investment banks is not so much and is getting less gradually. This will be much proved in the upcoming years by the results which will be seen after the expansion of the commercial banks which is happening, and the market structure which is becoming better due to the performance efficiency of investment banks!!
The data collected for this study is basically secondary data. The source is mainly internet, books, articles, and journals. The hypothesis for this study is basically to research and get findings to draw conclusion about the decreasing difference between commercial and investment banks. The mission of this research is the design of this literature which is available to be use for the further studies in this field, as well as to bring in the knowledge of people who are unaware of the growing trend of credit expansion by commercial banks so as the clients may better decide which way to go? Also it will be helpful to judge the functions of the commercial and investment banks and the entire services they are providing plus the similarities and dissimilarities among them are some topics which are studied through literature, figures, graphs etc in this paper.
This paper is written mainly keeping in eye the commercial and investment banks which are only two sub branches of the financial category bank. There are various types of banks which are performing differently but they are beyond the scope of this study. The study is just limited to two types, commercial and investment banks and we have discussed everything in general not in particular about some particular names of bank at work presently or working in some particular country but we have taken the hypothesis about general banking and all the terms, facts, figures and literature are used to be discuss this topic in general.
After conducting the whole study and finding out the facts and figures in order to prove the hypothesis drawn I would like to recommend few things to my fellows who will be interested to make amendments or to enhance this study by continuing the research.
1. firstly the data as I collected was mostly secondary data from some sources like internet, books ,journals etc, I would recommend that the data by giving it more time and effort should be collected primarily.
2. The sources can be the real market, the existing banks which are working and progressing vastly may provide real data. This data will be greatly helpful to draw more accurate conclusion about the actual working of these two institutions in the real world as discussed in this paper.
3. There can be use of statistical methods and formulation like correlation and regression to check the dependency of two variables, say commercial banks is variable X and investment bank is variable Y, on each other.
4. It can be written with more detailed literature view; the frame of the sample is the major cause of the details of any paper. As much expanded the frame is the maximum literature can be provided by the researcher.
5. Lastly I would like to recommend all the upcoming researches to try and create new techniques for old topics, to researched again and again and provide modification instead of applying the same previously used methods. The use of computer software has efficient knowledge can be very much helpful in this regard.
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A bank is: A financial institution that is licensed to deal with money and its substitutes by accepting time and demand deposits, making loans, and investing in securities. The bank generates profits from the difference in the interest rates charged and paid.
A bank is: A bank is an institute which deals in money. Broadly speaking banks draw surplus money from the people who are not using it at the time, and lend to those who are in a position to use it for productive purposes.
Commercial banks: Commercial banks: These are chiefly engaged in financing internal trade and also carry on other ordinary banking business of receiving deposits, advancing loans discounting bills etc.
Investment banks: Investment banks: Financial institutions that help corporations issue stocks and bonds in order to raise money. Unlike regular banks, they do not accept deposits or make loans.
Retail loans to companies financial services to companies and larger organizations. for raising capital and,
Lend money at interest rates
Take money as consultancy charges
MMDA: Money market deposit accounts
CD: Certificates of deposit.
ATM: Automatic teller machine
IFC: International finance group
SEC: Security exchange commission
IPO: Initial public offerings