Investment banks move large sums of money between corporations, governments, and wealthy individuals—they don't hold your checking account or take deposits the way a regular bank does.
An investment bank's core job is to connect people or organisations that have money with people or organisations that need it. They arrange loans for companies, help corporations sell stock to the public, advise on mergers and acquisitions, and trade securities on their own account. Unlike a commercial bank, which takes deposits and makes loans to individuals and small businesses, an investment bank works almost entirely with large institutions, governments, and very wealthy clients.
Investment banks make money through fees—a percentage of the deal size when they arrange a merger, a commission when they sell bonds or stock, or a spread when they trade. They also profit by holding and trading securities themselves, betting that prices will move in their favour. Because the sums involved are enormous, even small percentages add up to millions of dollars per transaction.
Key Takeaways
- Investment banks work with corporations and governments on large transactions, not with individual depositors or small business checking accounts.
- Their main revenue comes from fees on mergers, stock offerings, and bond sales, plus profits from trading securities they own.
- Investment banking divisions are separate from commercial banking divisions within the same company, though they often share a parent corporation.
- Investment banks use leverage—borrowed money—to amplify their trading profits, which also amplifies their losses when trades go wrong.
- Regulations separate investment banking from deposit-taking to reduce the risk that a bank's trading losses will threaten customer deposits.
How investment banks make money on mergers and acquisitions
When one company wants to buy another, an investment bank advises both sides on price, structure, and timing. They may also arrange financing for the buyer—finding lenders or investors willing to fund the deal. The bank charges a fee, usually a percentage of the total deal value, which can range from less than 1% on enormous deals to several percent on smaller ones. On a $1 billion acquisition, even 0.5% is $5 million in fees.
The investment bank's role is to know the market, know which companies might be interested in buying, and know how to value a target company. They also manage the legal and financial paperwork, coordinate with lawyers and accountants, and negotiate terms. The fee is paid whether the deal succeeds or fails, though some deals include a "success fee" that is higher if the transaction closes.
Underwriting: selling stock and bonds to raise capital
When a corporation or government needs to raise money, they can sell stock (equity) or bonds (debt) to the public. An investment bank underwrites this offering, meaning it buys the securities from the issuer at a set price and then sells them to investors at a higher price. The difference is the bank's profit.
For a stock offering, the investment bank also researches the company, writes a prospectus (a legal document describing the company and the risks), and coordinates with regulators. They may also stabilise the stock price immediately after the offering by buying shares if the price falls too quickly. For bonds, they handle similar work but the pricing is based on interest rates and credit risk rather than market demand for equity.
The bank's fee for underwriting is typically 3% to 7% of the amount raised, though it varies by market conditions and the complexity of the deal. On a $500 million bond offering at 4%, the bank earns $20 million.
Trading and proprietary investing
Investment banks trade securities—stocks, bonds, currencies, commodities, derivatives—on their own account, using their own capital and borrowed money. A trader might buy a bond at 99 cents on the dollar and sell it at 100 cents, pocketing the spread. Another might bet that a stock price will rise, buy it, and sell it higher. This is called proprietary trading because the bank is trading for itself, not on behalf of a client.
Proprietary trading can be highly profitable in good markets but devastating in bad ones. During the 2008 financial crisis, investment banks' trading losses were so large that several failed or required government rescue. Because of this, regulations now limit how much of a bank's capital can be used for proprietary trading, and banks must hold more capital in reserve to cover potential losses.
Investment banks also make money by trading on behalf of clients—a hedge fund or pension fund might pay the bank to buy or sell a large block of stock, and the bank charges a commission or keeps a small spread. This is lower-risk than proprietary trading because the bank is not betting its own money.
The difference between investment and commercial banking
A commercial bank takes deposits from individuals and businesses, pays interest on those deposits, and makes loans to borrowers. Your checking account is at a commercial bank. An investment bank does not take deposits and does not make loans to individuals or small businesses. Instead, it arranges large transactions and trades securities.
Many large financial institutions have both divisions. JPMorgan Chase, Bank of America, and Goldman Sachs all have commercial banking arms (which take deposits) and investment banking arms (which arrange deals and trade). These divisions are legally separate in some respects and must follow different rules, but they share the same parent company and often refer business to each other.
The separation exists because regulators want to prevent a bank's trading losses from threatening customer deposits. If an investment bank loses billions on a bad trade, the commercial bank's deposits should remain protected. In practice, the separation is imperfect—a parent company can still move money between divisions—but it creates a legal and operational barrier.
Leverage and risk in investment banking
Investment banks borrow heavily to amplify their profits. If a bank has $10 billion in capital and borrows $90 billion, it can invest $100 billion in securities. If those securities rise 10%, the bank makes $10 billion in profit on its $10 billion capital—a 100% return. But if the securities fall 10%, the bank loses $10 billion and is wiped out.
This is called leverage, and it is how investment banks generate outsized returns in good times. But leverage also means that small losses can become catastrophic. During the 2008 crisis, investment banks had leverage ratios of 30:1 or higher, meaning they had borrowed $30 for every $1 of capital. When asset prices fell, many banks became insolvent overnight.
Regulators now require investment banks to hold more capital and limit their leverage ratios. The goal is to ensure that a bank can absorb losses without failing. But investment banks still use significant leverage because it is central to their business model.
How investment banks differ from hedge funds and private equity
Investment banks, hedge funds, and private equity firms all manage money and make investments, but they operate differently. An investment bank is usually part of a larger financial institution and makes money from fees and trading. A hedge fund is a private investment firm that manages money for wealthy clients and takes a percentage of profits. Private equity firms buy companies outright, restructure them, and sell them for a profit.
Investment banks advise on deals but do not usually own the companies involved. Hedge funds and private equity firms invest their own capital (and their clients' capital) in the hope of making returns. Investment banks profit regardless of whether a deal succeeds or fails, as long as they collect their fees.
Frequently Asked Questions
Do investment banks take deposits like regular banks?
No. Investment banks do not offer checking accounts, savings accounts, or deposit services. They work exclusively with large institutions and wealthy clients on transactions and trading. If you have a checking account at a bank that also has an investment banking division, your deposits are held by the commercial banking side, not the investment banking side.
How do investment banks make money if a deal falls through?
Most investment banking fees are paid when the deal closes, so a failed deal means no fee. However, some advisory contracts pay a retainer or success fee structure that may include a payment even if the deal does not complete. The bank also covers its costs through the fees it does collect on successful deals.
Why do investment banks need so much borrowed money?
Leverage amplifies returns. A bank with $10 billion in capital can invest $100 billion if it borrows $90 billion, turning a 1% gain into a 10% return on its own money. This is how investment banks generate the high profits needed to pay traders and bankers large salaries. The trade-off is that losses are also amplified.
Can I invest with an investment bank?
Most investment banks do not accept individual investors. They work with institutions like pension funds, insurance companies, and hedge funds, or with very high-net-worth individuals (typically $10 million or more in assets). If you want to invest, you would use a brokerage firm or a wealth management service, which may be part of the same parent company as an investment bank but operates under different rules.
What happened to investment banks during the 2008 financial crisis?
Several large investment banks failed or were forced to merge. Lehman Brothers collapsed, Bear Stearns was bought by JPMorgan Chase, and Merrill Lynch was bought by Bank of America. The crisis exposed the risks of high leverage and poor risk management. Regulators responded by requiring banks to hold more capital and limiting leverage ratios.