In finance theory, investment means the process of buying securities or other financial assets. Thus, a simple way of defining what investment banks do is to say that they invest, i.e. purchase new securities from corporate issuers and resell them to the public, in addition to their activities (trading of securities) on capital markets.
Investment banks differ from commercial banks in that they facilitate companies’ direct access to the capital markets, as opposed to an intermediary role between customers who save money and those who borrow it.
Core functions of the investment banks include: a) transferring economic resources, b) management of risk, and c) clearance and settlement of transactions across different time zones beyond national borders. Investment banks significantly expand the menu of products and services which are: a) cash money lending, b) structured finance, c) fund management, and d) securities transactions to retail and institutional clients (Liaw, 2006).
The cost of entering the investment banking industry is high, because new entrants need to establish cross-border information and communication networks and hire bright and energetic specialists. The profitability of the investment banking business depends on its ability to reduce operational costs in the continuous flow of a large number of transactions. It is important for investment banks to: a) obtain a high market share in the key business functions such as mergers and acquisitions (M&A), advisory and securities issuance, and b) develop a broad range of products in order to activate cross-selling to various clients (Roberts, 2004).
In the wake of the recent financial crisis, which has seen some big names in investment banking, such as Bear Stearns and Lehman Brothers, disappear from the scene, the traditional view of investment banking has been slightly altered. This is because in 2008, banking giants such as Morgan Stanley and Goldman Sachs, who were model standalone investment banks and the two remaining major investment banks in the USA, had to change their status to bank holding companies.
The move allowed both banks to have permanent access to emergency funding from the US Federal Reserve but also meant changes to the ways they were regulated. The conversion to commercial bank status will also allow Goldman Sachs and Morgan Stanley to bolster their funding through deposits.