Question

What are the differences between commercial banking, investment banking and hedge funds? Describe their main functions and briefly explain the way their balance sheets differ from each other. Lastly explain the regulatory framework that applies to each one of these different types of financial institutions.

500-700 words.

Answer 1

Commercial banking deals with the service provided by financial intermediaries such as banks for the purpose of receiving deposits and providing the interest for the deposits that have been accepted by the bank, and lending money to people and organizations that are in need of funds and thereby charging them interest for the amount that they had borrowed.

Whereas, Investment banking deals with assisting large organizations or establishments manage their funds by providing them services such as assisting them in creation of capital when the company is going public (IPO – Initial Public Offer) or sell debt security instruments such as bonds or debentures, when they want to sell their ownership to a certain company or individual, when the companies are going for a merger, or when a large company wants to acquire one of its competitors, etc.

Unlike the above two Hedge Funds are a form of a partnership between an investment manager and an investor who can also be termed as a fund manager and a limited partner respectively. The main goal of a hedge fund is to make the most returns from the investment and to manage the risk on the investment made by the investor.

The main functions of:

1. Commercial Banking - Accepting Deposits, Lending Loans, Act as an Agent and Provide utility services.

2. Investment Banking - Act as an intermediary between companies during an IPO, Underwriting new stock, Equity Research, Equity Research, Asset Management, etc.,

3. Hedge Funds - Portfolio Managers, Investment and Wealth Management, Risk Management, etc.,

The balance sheets of the Commercial Banks, Investment Banks, and Hedge Funds are different in terms of the source and use of funds.

In the balance sheet of the commercial banks, the deposits accepted by the banks from the customers are treated as current or long-term liabilities as per the duration of the deposits, and the Loans provided to them are considered as assets, and if the repayment of the said loans default they are considered as non-performing assets. They usually invest in fixed income securities that are highly liquid and secure in order to meet the deposit withdrawal by the customers.

The balance sheet of Investment Banks, on the other hand, is similar to the commercial banks but they have a diverse set of assets as they manage the investment of the clients, who would prefer in getting a higher return rather than a small consistent return from fixed income securities.

Whereas the balance sheet of the hedge funds show different sectors and securities in which the funds of the investor has been invested by the fund manager in order to eliminate the risk and obtain a higher return some of the various assets include land, currency, equity, bonds, commodities, precious metals, etc.,

Usually, the cash balance is maintained at a minimum in order to obtain the maximum return on the investment.

Commercial banks are profoundly directed by federal specialists, for example, the Federal Reserve and the Federal Deposit Insurance Corporation (FDIC). Commercial banks are guaranteed by the federal government to keep up assurance for client accounts and give a specific degree of security. Investment banks contrast since they are substantially more approximately directed by the Securities and Exchange Commission (SEC). The Commission offers less security to clients and permits investment banks a lot of operational opportunities, the same goes for the hedge funds.