An investment bank is a financial firm that helps large companies and governments raise money by issuing stocks or bonds, and also trades securities and provides advisory services for mergers and acquisitions.
Investment banks differ from retail banks — the kind where you have a checking account. A retail bank takes deposits from individuals and lends that money out as mortgages and car loans. An investment bank does not take deposits. Instead, it earns money by charging fees for services, taking a cut of transactions, and trading securities on its own account.
If you own individual stocks or mutual funds, you may never directly interact with an investment bank. But investment banks shape the market you trade in. They underwrite new stock offerings, they make markets in bonds, and they execute large trades that move prices. Understanding what they do helps explain how capital flows through the financial system and why certain fees exist.
Key Takeaways
- Investment banks earn money through underwriting fees (helping companies issue stocks or bonds), trading commissions, and advisory fees for mergers and acquisitions — not from customer deposits.
- The underwriting process means an investment bank buys newly issued securities from a company and resells them to investors, taking the risk that it cannot sell them all.
- Investment banks also operate trading desks that buy and sell securities for their own profit, which creates a conflict of interest with their advisory clients.
- Major investment banks like JPMorgan Chase, Goldman Sachs, and Morgan Stanley operate globally and handle transactions worth trillions of dollars annually.
How Investment Banks Raise Capital Through Underwriting
When a large company decides it needs to raise money, it often turns to an investment bank to help issue new stock or bonds. The investment bank's role is called underwriting. The bank agrees to buy all the newly issued securities from the company at a set price, then resells them to institutional investors, hedge funds, pension funds, and sometimes retail investors.
The investment bank takes on the risk that it cannot sell all the securities at the price it paid. If demand is weak, the bank absorbs the loss. If demand is strong, the bank profits on the spread between what it paid and what it sold for. The company pays the investment bank a fee — typically 3 to 7 percent of the total amount raised — regardless of whether the bank profits or loses on the resale.
This is how most new stock offerings and corporate bond issuances reach the market. Without investment banks willing to underwrite, companies would have a much harder time raising large amounts of capital quickly.
Trading and Market-Making Operations
Investment banks operate trading desks where they buy and sell stocks, bonds, currencies, and derivatives. Some of this trading is on behalf of clients — a pension fund asks the bank to buy a large block of shares, and the bank executes that trade and charges a commission. But investment banks also trade for their own accounts, betting that prices will move in their favor.
When an investment bank "makes a market" in a security, it means the bank stands ready to buy or sell at any time. The bank quotes a bid price (what it will pay) and an ask price (what it will sell for). The difference between those two prices — the spread — is the bank's profit. On heavily traded securities like major stocks or Treasury bonds, spreads are tiny. On less liquid securities, spreads are wider and the bank's profit per trade is larger.
This trading operation is profitable during normal markets but can become a major source of losses during crises, when prices move sharply and the bank gets stuck holding securities it cannot sell quickly.
Mergers, Acquisitions, and Advisory Services
Investment banks advise companies on mergers and acquisitions — when one company buys another or two companies combine. The bank helps the client company decide whether a deal makes financial sense, identifies potential targets or buyers, negotiates terms, and structures the transaction. Investment banks charge substantial advisory fees for this work, often a percentage of the deal value.
A conflict of interest exists here: the same investment bank may advise both the buyer and the seller in a transaction, or may advise a company on a merger while also trading that company's stock for its own profit. Regulations require disclosure of these conflicts, but they remain a structural feature of how investment banks operate.
The Difference Between Investment Banking and Wealth Management
Many large investment banks also operate wealth management divisions that serve high-net-worth individuals — people with millions of dollars to invest. Wealth managers help these clients build investment portfolios, plan taxes, and manage estates. This business is separate from investment banking, though both operate under the same corporate umbrella.
Wealth management is a retail business (even though the clients are wealthy), while investment banking is a wholesale business serving corporations and institutions. A wealth manager might recommend that a client buy shares in a company, while the investment banking division of the same firm is underwriting that company's new stock offering. Again, disclosure rules apply, but the potential for conflicts is built in.
How Investment Banks Differ From Retail Banks
A retail bank like Bank of America or Wells Fargo takes deposits from individuals and businesses, pays interest on those deposits, and lends the money out as mortgages, car loans, and business loans. The bank's profit comes from the spread between the interest rate it pays depositors and the rate it charges borrowers.
An investment bank does not take deposits and does not make traditional loans. It earns money from fees, trading profits, and underwriting spreads. Some large financial institutions — JPMorgan Chase, Bank of America, Citigroup — operate both a retail bank and an investment bank under the same holding company. The two divisions are supposed to be separate, with restrictions on how much they can share information or coordinate activities. These restrictions exist because of the 2008 financial crisis, when conflicts of interest between retail and investment banking operations contributed to systemic risk.
Major Investment Banks and Their Global Reach
The largest investment banks operate globally and handle enormous transaction volumes. JPMorgan Chase, Goldman Sachs, Morgan Stanley, Bank of America Merrill Lynch, and Citigroup are among the largest in the United States. Internationally, Deutsche Bank, Barclays, UBS, and Credit Suisse are major players. These firms employ thousands of bankers, traders, and analysts across dozens of countries.
The scale of these operations means that investment banks have significant influence over capital markets. When an investment bank decides to stop making markets in a particular security or sector, it can affect prices and liquidity for everyone. During the 2008 financial crisis and the 2020 pandemic market shock, investment banks' decisions about whether to keep trading affected how quickly markets recovered.
Frequently Asked Questions
Do I need an investment bank to buy stocks?
No. You can open a brokerage account with a retail broker like Fidelity, Charles Schwab, or E-Trade and buy stocks directly. Investment banks primarily serve large institutions and corporations, not individual investors. Your retail broker may use an investment bank to execute very large trades on your behalf, but you do not interact with the investment bank directly.
Why do investment banks charge such high fees?
Investment banking requires specialized expertise, carries significant risk (especially in underwriting), and involves large sums of money. A 5 percent underwriting fee on a $1 billion bond offering generates $50 million in revenue for the bank. Advisory fees for mergers and acquisitions can run into the hundreds of millions for large deals. These fees reflect the complexity of the work and the bank's willingness to take on risk.
Can investment banks fail?
Yes. Investment banks failed during the 2008 financial crisis — Lehman Brothers collapsed, and Bear Stearns was forced into a merger with JPMorgan Chase. Since then, regulations require large investment banks to hold more capital and undergo regular stress tests to ensure they can survive severe market downturns. However, the risk of failure remains, particularly during financial crises.
What is the difference between an investment bank and a hedge fund?
An investment bank is a financial services firm that earns fees for services and trades for its own account. A hedge fund is an investment fund that pools money from investors and uses that capital to make trades and investments. Hedge funds typically take larger risks and use more complex strategies than investment banks. Some investment banks operate hedge funds as separate divisions.
How do investment banks affect stock prices?
Investment banks affect prices through underwriting (new supply of shares), market-making (bid-ask spreads and trading volume), and research (analyst reports that influence investor sentiment). When an investment bank underwrites a large stock offering, it increases the number of shares available, which can pressure the price downward. When a bank's trading desk buys or sells large blocks of stock, it can move prices directly.