Investment banks are essentially financial intermediaries, who primarily help businesses and governments with raising capital, corporate mergers and acquisitions, and securities trade. In USA such banks are the most important participants in the direct market by bringing financial claims for sale. They help interested parties in raising capital, whether debt or equity in the primary market to finance capital expenditure.
Once the securities are sold, investment bankers make secondary markets for the securities as brokers and dealers. In 1990, there were 2500 investment banking firms in USA doing underwriting business. About 100 firms are so large that they dominate the industry. In recent years some investment banking firms have diversified or merged with other financial institutions to become full service financial firms.
Difference between Investment Banks and Commercial Banks
Investment banks have often been thought to be as Commercial banks, and rightly so. However, both the terms have different connotations in United States. Early investment banks in USA differed from commercial banks, which accepted deposits and made commercial loans. Commercial banks were chartered exclusively to issue notes and make short-term business loans. On the other hand, early investment banks were partnerships and were not subject to regulations that apply to corporations. Investment banks were referred to as private banks and engaged in any business they liked and could locate their offices anywhere. While investment banks could not issue notes, they could accept deposits as well as underwrite and trade in securities.
As put forth earlier, the distinction between commercial banks and investment banks is unique and is confined to the United States, where it is by legislation that they are separated. In countries where there is no legislated separation, banks provide investment-banking services as part of their normal range of banking activities. Coming back to countries where investment banking and commercial banking are combined. Such countries have what is known as universal banking system. Say for example, European Countries have universal banking system, which accepts deposits, make loans, underwrites securities, engage in brokerage activities and offer financial services.
Scenario for Investment Banking in India?
In India commercial banks are restricted from buying and selling securities beyond five percent of their net incremental deposits of the previous year. They can subscribe to securities in the primary market and trade in shares and debentures in the secondary market. Further, acceptance of deposits is limited to commercial banks. Non-bank financial intermediaries accept deposits for fixed term are restricted to financing leasing/hire purchase, investment and loan activities and housing finance. They cannot act as issue managers or merchant banks. Only merchant bankers registered with the Securities and Exchange Board of India (SEBI) can undertake issue management and underwriting, arrange mergers and offer portfolio services. Merchant banking in India is non-fund based except underwriting.