An investment bank, which includes the likes of Bank of America, JPMorgan Chase, and Goldman Sachs, finances or facilitates trades and investment on a large scale for institutional clients. But that is an overly simplistic view of how investment banks make money. There are, in fact, several facets to what they do.
Key Takeaways
- Investment banks provide a variety of financial services, including research, trading, underwriting, and advising on M&A deals.
- Proprietary trading is an effort to make profits by trading the firm's own capital.
- Investment banks earn commissions and fees on underwriting new issues of securities via bond offerings or stock IPOs.
- Investment banks often serve as asset managers for their clients as well.
Brokerage and Underwriting Services
Like traditional intermediaries, large investment banks connect buyers and sellers in different markets. For this service, they charge a commission on trades. The trades range from simple stock trades for smaller investors to large trading blocks for big financial institutions.
Investment banks also perform underwriting services when companies need to raise capital. For example, a bank might buy stock in an initial public offering (IPO), and then market the shares to investors. There is a risk that the bank will be unable to sell the shares for a higher price, so the investment bank might lose money on the IPO. To combat this risk, some investment banks charge a flat fee for the underwriting process.
Mergers and Acquisitions
Investment banks charge fees to act as advisors for spinoffs and mergers and acquisitions (M&A). In a spinoff, the target company sells a piece of its operation to improve efficiency or to inject cash flow. On the other hand, acquisitions occur whenever one company buys another company. Mergers take place when two companies combine to form one entity. These are often complicated deals and require a lot of legal and financial help, especially for companies unfamiliar with the process.
Creating Collateralized Products
Investment banks might take lots of smaller loans, such as mortgages, and then package those into one security. The concept is somewhat similar to a bond mutual fund, except the collateralized instrument is a collection of smaller debt obligations rather than corporate and government bonds. Investment banks must purchase the loans to package and sell them, so they try to profit by buying cheap and selling at higher prices on the market.
Proprietary Trading
With proprietary trading, the investment bank deploys its own capital into the financial markets. Traders that risk the firm's capital are typically compensated based on performance, with successful ones earning large bonuses and unsuccessful traders losing their jobs. Proprietary trading has been much less prevalent since new regulations were imposed after the 2007-2008 financial crisis.
Dark Pools
Suppose an institutional investor wants to sell millions of shares, a size that's large enough to impact markets right away. Other investors in the market might see the big order and this opens the opportunity for an aggressive trader with high-speed technology to front-run the sale in an attempt to profit from the coming move. Investment banks established dark pools to attract institutional sellers to secretive and anonymous markets to prevent front-running. The bank charges a fee for the service.
Swaps
Investment bankers sometimes make money with swaps. Swaps create profit opportunities through a complicated form of arbitrage, where the investment bank brokers a deal between two parties that are trading their respective cash flows. The most common swaps occur whenever two parties realize they might mutually benefit from a change in a benchmark, such as interest rates or exchange rates.
Market Making
Investment banks often have market making operations that are designed to generate revenue from providing liquidity in stocks or other markets. A market maker shows a quote (buy price and sale price) and earns a small difference between the two prices, also known as the bid-ask spread.
Investment Research
Major investment banks can also sell direct research to financial specialists. Money managers often purchase research from large institutions, such as JPMorgan Chase and Goldman Sachs, to make better investment decisions.
Asset Management
In other cases, investment banks directly serve as asset managers to large clients. The bank might have internal fund departments, including internal hedge funds, which often come with attractive fee structures. Asset management can be quite lucrative because the client portfolios are large.
Lastly, investment banks sometimes partner with or create venture capital or private equity funds to raise money and invest in private assets. The idea is to buy a promising target company, often with a lot of leverage, and then resell or take the company public after it becomes more valuable.
The Bottom Line
In a capitalist economy,investment bankersplay a role in helping their clients raise capital to finance various activities and grow their businesses. They are financial advisory intermediaries who help price capital and allocate it to various uses.
While this activity helps smooth the wheels of capitalism, the role of investment bankers has come under scrutiny becausethere is some criticism that they are paid too much in relation to the services they provide.
FAQs
Investment banks earn commissions and fees on underwriting new issues of securities via bond offerings or stock IPOs. Investment banks often serve as asset managers for their clients as well.
How does JP Morgan make money? ›
Key Takeaways. JPMorgan provides financial services to consumers, small businesses, large corporations, governments, and other clients. The company's Consumer & Community Banking segment is the largest source of revenue.
How do banks make money from investment accounts? ›
Investment Banking: Handles complex financial deals like mergers, buying other companies, and selling stocks. Here, investment banking plays an active role in financial markets for the chance at high earnings. Investment banks mainly make money from fees for these services, including advice and transaction fees.
Why is investment banking so profitable? ›
But what exactly drives the stratospheric earnings of investment bankers? At the heart of an investment banker's earning potential lies their involvement in high-value deals and transactions. These professionals facilitate mergers, acquisitions, and IPOs for corporations, reaping substantial fees in the process.
Why are investment bankers so rich? ›
Investment bankers make money through the fees charged to their clients. As discussed above, this includes underwriting fees for arranging the sale of securities and advisory fees for providing strategic guidance.
Do investment bankers make 500K a year? ›
Ways to make a lot of money in this world
Sure, anybody can make a good living being a doctor or a lawyer or an investment banker where you can make ~$200-500K per year a few years after you finish with your studies, but you hit a ceiling very quickly unless you start your own practice (aka start your own business).
How does Goldman Sachs make money? ›
Equities. Goldman Sachs makes markets in and trades equities and equity-related products, structures and enters into equity derivative transactions and engages in proprietary trading and equity arbitrage; and. Principal Investments.
How do M&A firms make money? ›
M&A advisory firms typically base their fees on a percentage of the sale transaction. The fee can vary, based on the type of company and its value. Some may also charge a flat retainer fee to secure their services.
Who gets paid the most at J.P. Morgan? ›
Some of the highest wages a worker can make at J.P. Morgan are in the job titles Senior Software Engineer ($225,000), and title Senior Software Engineering Manager ($219,076) which are the highest paying jobs at J.P. Morgan.
What part of investment banking makes the most money? ›
Finance roles that typically pay the most include positions such as investment banking managing directors, hedge fund managers, or private equity partners. Chief financial officers (CFOs) of large corporations are also highly paid positions.
Commercial banks make money by providing and earning interest from loans [...]. Customer deposits provide banks with the capital to make these loans. Traditionally, money earned in the form of interest from loans often accounts for up to 65% of a banks' revenue model.
What are three ways banks make money? ›
They earn interest on the securities they hold. They earn fees for customer services, such as checking accounts, financial counseling, loan servicing and the sales of other financial products (e.g., insurance and mutual funds).
Can investment bankers make millions? ›
It is possible to become a millionaire as an investment banker, but it is not easy. Investment bankers typically earn salaries in the $200,000 to $700,000 range, with bonuses that can bring their total income up to several million dollars per year.
Why is investment banking so stressful? ›
The intense competition, constant deadlines, aggressive atmosphere, high-stress environment and lack of work-life balance have been linked to mental health issues and burnout among financial services employees, with many considering leaving their jobs due to the impact on their well-being.
Why do investment bankers get such big bonuses? ›
Bonuses make up the majority of an investment banker's total compensation and are largely influenced by individual performance and bank profits. The highest paying investment banks are typically the large Wall Street firms like Goldman Sachs, JP Morgan, Morgan Stanley, etc.
Do investment bankers really make a lot of money? ›
Can you become a millionaire as an investment banker? It is possible to become a millionaire as an investment banker, but it is not easy. Investment bankers typically earn salaries in the $200,000 to $700,000 range, with bonuses that can bring their total income up to several million dollars per year.
Do investment bankers make 7 figures? ›
How can you earn a six-figure salary at top investment banking firms without any experience in 2023. On average, a first-year investment banker makes a 5-digit salary, in the range of $70,000 – $90,000, while a 7-digit salary is considered above average and is difficult to achieve for most people in their careers.
How do investment bankers raise money? ›
Investment banks primarily help clients raise money through debt and equity offerings. This includes raising funds through Initial Public Offerings (IPOs), credit facilities with the bank, selling shares to investors through private placements, or issuing and selling bonds on behalf of the client.
What percentage do investment bankers take? ›
Investment Banker Fees
On average, the commission for a business with a $5 million to $10 million value will be approximately five percent of the transaction value. For businesses with values greater than $10 million, the commission will generally decline from five percent as the transaction value increases.
