Investment banks help companies and governments raise money and handle large financial deals, but they work differently from the retail banks where you keep a checking account

An investment bank is a financial firm that arranges and advises on major transactions — things like helping a company sell stock to the public for the first time, arranging a merger between two large corporations, or helping a government issue bonds. They do not take deposits or offer savings accounts. Instead, they make money by charging fees on the deals they structure and by trading securities on their own account.

The work happens in two main divisions. The advisory side gives strategic advice to corporations and governments on how to raise capital or restructure their business. The trading side buys and sells stocks, bonds, and other securities — both for clients and for the bank's own profit. Some investment banks also manage money on behalf of wealthy individuals and institutions, which is called wealth management or asset management.

Investment banks are different from commercial banks (which take your deposits and make loans) and from brokerages (which execute trades for individual investors). But many large financial institutions now operate all three divisions under one corporate umbrella.

Key Takeaways

  • Investment banks charge fees to advise on and arrange major financial deals like initial public offerings, mergers, and bond issuances — they do not take deposits.
  • The advisory division helps corporations and governments raise money or restructure; the trading division buys and sells securities for clients and for the bank itself.
  • Investment banks make money from deal fees, trading profits, and asset management charges, not from interest on savings accounts.
  • Large investment banks operate globally and handle transactions worth billions of dollars, while smaller regional firms focus on local and mid-market deals.

How investment banks make money on deals

When a company decides to go public — to sell shares to the general public for the first time — it hires an investment bank to manage the process. This is called an initial public offering or IPO. The bank advises on pricing, prepares the legal documents, lines up investors, and coordinates the sale. For this work, the bank typically takes a percentage of the money raised, usually between 3 and 7 percent.

When two large companies merge or one buys another, the investment bank advises both sides (or sometimes just one) on the deal structure, negotiates terms, and handles the financial engineering. The fee is often a percentage of the deal value, which can be millions of dollars for a large transaction.

Governments also use investment banks. When a city or state needs to borrow money, it issues bonds — essentially IOUs that investors buy. The investment bank helps structure the bond offering, markets it to investors, and takes a fee. The same process happens at the federal level, though the U.S. Treasury runs its own auctions.

These advisory fees are predictable and relatively low-risk for the bank. The bank does not put its own money at risk; it simply charges for its expertise and connections.

How investment banks profit from trading

The trading division buys and sells securities — stocks, bonds, currencies, commodities — constantly throughout the day. Some of this trading is on behalf of clients: a large pension fund might ask the bank to buy a block of shares, and the bank executes the order and takes a commission. But investment banks also trade for their own account, betting that they can buy low and sell high.

This is where investment banks take real risk. If a trader buys a large position in a stock and the price falls, the bank loses money. During the 2008 financial crisis, several major investment banks suffered enormous trading losses and had to be rescued by the government. The Dodd-Frank Act, passed in 2010, now limits how much of their own money banks can risk on proprietary trading (called the Volcker Rule), though the rule has been modified several times since.

Trading profits can be enormous in good years and devastating in bad ones. This volatility is one reason investment banks are considered riskier than commercial banks, which earn steady income from lending.

The difference between investment banks and other financial firms

A commercial bank takes deposits from individuals and businesses, pays interest on savings accounts, and lends money out at a higher rate. Wells Fargo, Bank of America, and Chase are primarily commercial banks, though they all own investment banking divisions too.

A brokerage executes trades for individual investors — you call your broker and say "buy 100 shares of Apple," and they do it. Brokerages charge commissions or take a small spread on each trade. Fidelity, Charles Schwab, and E-Trade are brokerages. Some brokerages also offer advisory services, where a financial advisor helps you build a portfolio.

An investment bank does not serve retail customers at all. It works with corporations, governments, and very large institutional investors. The minimum deal size is usually in the millions of dollars. If you want to invest money, you would go to a brokerage or a financial advisor, not an investment bank.

Many large financial institutions now operate all three businesses. JPMorgan Chase, for example, has a commercial banking division (where you can open a checking account), a brokerage division (where you can trade stocks), and an investment banking division (which advises on mergers and IPOs). This structure is called universal banking.

What investment bankers actually do day-to-day

Investment bankers on the advisory side spend much of their time in meetings with clients, understanding their business and their financial goals. They build financial models — spreadsheets that project future revenue and costs — to show how a deal might work. They write pitch books, which are presentations designed to win a client's business. They coordinate with lawyers, accountants, and other advisors.

The work is often intense and involves long hours, especially when a deal is in progress. Junior bankers (called analysts and associates) do much of the detailed modeling and document preparation. Senior bankers (called managing directors or partners) manage client relationships and make strategic decisions.

Traders spend their day watching markets, monitoring positions, and making buy-and-sell decisions. They work in teams and communicate constantly with clients, other traders, and risk managers. The pace is fast and the pressure is high, especially during volatile market conditions.

Investment bankers are paid differently than other financial professionals. Base salaries are often modest, but bonuses can be enormous — sometimes several times the base salary — if the bank has a good year and the individual's deals are profitable. This incentive structure is designed to attract ambitious people and align their interests with the bank's profits, but it also creates pressure to take risks.

Why investment banks matter to the broader economy

Investment banks are the infrastructure that allows large capital flows to happen. When a company needs to raise $500 million to build a new factory, an investment bank finds the investors willing to provide that money. When two companies merge, an investment bank structures the deal so both sides understand the financial terms. When a government needs to borrow, an investment bank helps it reach investors.

Without this infrastructure, capital would move much more slowly and inefficiently. Companies would have a harder time raising money, mergers would be more difficult to arrange, and governments would pay higher interest rates on their borrowing.

But investment banks also create systemic risk. Because they are so large and so interconnected — they lend to each other, trade with each other, and hold each other's debt — a failure at one major bank can spread to others. This is what happened in 2008, when the collapse of Lehman Brothers triggered a broader financial crisis. Since then, regulators have imposed stricter capital requirements and stress tests on large banks to reduce the chance of another systemic failure.

The main investment banks and their market position

The largest investment banks in the world are JPMorgan Chase, Bank of America Merrill Lynch, Goldman Sachs, Morgan Stanley, and Citigroup. These firms handle the biggest deals and have the most extensive global networks. They compete fiercely for business and often work together on very large transactions.

Below them is a second tier of large regional and international banks — firms like Barclays, Deutsche Bank, Credit Suisse, and UBS — that handle major deals but have smaller market share. There are also hundreds of smaller boutique investment banks that specialize in particular industries or types of deals.

The investment banking business is highly concentrated. The top five firms handle a large percentage of all IPOs and mergers. This concentration means that if you are a large corporation or government, you probably work with one of the major banks. If you are a smaller company, you might work with a regional or boutique firm.

Frequently Asked Questions

Can I invest money with an investment bank?

Not directly. Investment banks work with corporations and governments on large deals, not with individual investors. If you want to invest money, you would use a brokerage, a financial advisor, or a wealth management firm. Some large investment banks do have wealth management divisions that serve very high-net-worth individuals, but the minimum account size is typically in the millions of dollars.

How do investment banks differ from hedge funds?

Investment banks are financial intermediaries that advise on deals and trade securities. Hedge funds are investment firms that manage money on behalf of wealthy investors and institutions, taking a percentage of the profits. Hedge funds take more risk and use more aggressive strategies than investment banks typically do. Some investment banks own hedge funds or hedge fund-like divisions, but they are separate businesses.

Why do investment bankers make so much money?

Investment bankers are paid based on the deals they close and the profits they generate. A single deal can be worth millions of dollars in fees, and a successful banker might close several deals per year. The pay also reflects the long hours, high stress, and specialized skills required. However, compensation is highly variable — a banker at a firm that has a bad year might earn far less than one at a firm with a good year.

What happened to investment banks during the 2008 financial crisis?

Several major 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 government provided emergency loans and capital injections to stabilize the system. Since then, regulations have been tightened to reduce the risk of another crisis.

Do investment banks still do proprietary trading?

Yes, but in a more limited way than before 2008. The Volcker Rule restricts how much capital banks can use for proprietary trading (trading for their own account rather than for clients). However, the rule has been modified and debated since its passage, and banks still engage in significant trading activities. The exact limits depend on how regulators interpret the rule.