What is Investment Banking?

What is Investment Banking?
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"Investment banking" is a term that's used a lot in financial news media because most investment banks – Goldman Sachs®, for instance – are heavy hitters that make for good reading and stimulating conversation. But what exactly is investment banking and what do investment bankers do? Historically, one thing they haven't done routinely is what we normally think of as banking.

What Is Investment Banking?

The simplest way to explain investment banking is that the activities of investment banks nearly always have something to do with the redistribution of capital. These banks deal almost entirely with other large institutions and a few of the wealthiest private investors, underwriting (guaranteeing) the issuance of debt, corporate stock and other securities, enabling mergers of institutions and acquisitions of one institution by another as well as providing advice on financial activities to corporate clients.

What makes describing investment banking initially confusing is that most of the largest investment banking institutions, such as Credit Suisse®, Citibank® and J.P. Morgan Chase®, also engage in other banking activities – the kinds of activities that come to mind when consumers think of banks in general. These other activities, however, have their own divisions that are run separately from investment banking divisions.

What Do You Do in Investment Banking?

In the past, investment banks typically didn't accept retail client deposits, manage checking and savings accounts, make car loans, mortgage loans and loans to small businesses, provide individual mortgages to homeowners or engage in other retail banking services.

In the 21st century, however, these large financial institutions have broadened their activities to connect with consumers. As of 2018, this trend seems likely to continue as even Goldman Sachs, one of the oldest investment banks and, historically, purely an investment banking institution, has created a Marcus platform expressly for retail banking activities such as providing consumer small loans and savings accounts. Some investment banks, like Bank of America Merrill Lynch®, also provide retail investment services.

Financial Reform and the Changing Roles of Investment Banks

One reason that investment banks today have begun changing their roles – moving, for example, into the consumer market – is that many of their historical activities have been scrutinized and in some cases limited by Congressional financial reforms following the Great Recession. Senator Carl Levin, writing in 2010 about the need for reform, singled out Goldman Sachs' behavior leading up to the housing market collapse in late 2007, writing that its "activities contributed to the economic collapse that came full-blown the following year (i. e., 2008).

One of the principal outcomes of Congressional hearings related to the collapse is the Dodd-Frank act, which addresses to issues particularly:

  • Bank liquidity. Higher capital requirements to assure that major banks remain solvent in times of crisis (Lehman Brothers, for instance, failed entirely early in the crisis) and many additional safeguards to prevent the unwinding of the mortgage industry.
  • Regulatory discretion over how banks can operate, shifting the balance of power toward regulators and away from large banks, particularly, which, of course, describes all the major U.S. investment banks. 

Dodd-Frank has been severely criticized as irresponsible overkill, mostly by Republican members of Congress, and in 2018 there have been some minor Congressional adjustments lowering the original bill's impact on banks, but in general the post-Recession regulatory environment for investment banks has made it much harder and less profitable to do business.

Tips for Working With Investment Banks

Many people have complicated feelings about investment banks. On the one hand, it's generally acknowledged that investment banking activities are essential in a capitalist society. The 2008 collapse of just one prominent investment banking institution, Lehman Brothers®, is generally viewed as the one single event that did most to lead the country into the Great Recession. On the other hand, the inescapable fact that investment banks are extremely wealthy institutions with multi-millionaire and billionaire senior management providing investment banking services exclusively to other extremely wealthy institutions makes them objects of popular (and populist) resentment and scorn – all of this summed up in the unforgettable description of Goldman Sachs in a 2009 Rolling Stone article as "a great vampire squid wrapped around the face of humanity, relentlessly jamming its blood funnel into anything that smells like money."

As a practical matter, at some point, almost inevitably, you'll interface with the retail banking divisions of these important investment banking institutions, sometimes successfully and helpfully and at other times not – which characterizes consumer interfaces with any financial institution. What Goldman Sachs may have paid Hillary Clinton in 2016 in speaking fees (an act loudly deplored by political conservatives and moderates alike), really doesn't affect your loan application to Goldman Sachs' Marcus division. In all cases and with all financial institutions, your best way forward as an individual consumer is to investigate carefully the offerings of several institutions and then to choose the one that suits you best.