Question

1) In the spirit of financial intermediaries, compare and contrast the basic functions and clients of a classic investment bank (e.g., Goldman Sachs) with a classic commercial bank (e.g., Bank of Bethesda). Again, as financial intermediaries, how do commercial banks and investment banks generally differ, if at all, from insurance companies, venture capital funds, or public pension funds?

Answer 1

Investment banks and commercial banks are the two major type of financial institutions, they play a pretty different role in the economy. Let's discuss some of these.

Functions of investment bank

1. IPO – Corporate players usually need funding to operate their business and one of the biggest source of raising fund is an IPO Or an initial public offering. The investment banks play a an important role in the IPO process, from valuation to selling the new issued shares of the company. An investment bank takes care of it. They often have clients who are willing to raise funds through equity or issue bonds.
2. M&A advisory service - Mergers and acquisitions (M&A) advisory is the process of helping corporations and institutions find, evaluate, value, and complete acquisitions of businesses. Banks use their extensive networks and relationships to find opportunities and help negotiate on their client’s behalf. Bankers advise on both sides of M&A transactions, representing either the “buy side” or the “sell side” of the deal.
3. Sales & Trading – Matching up buyers and sellers of securities in the secondary market.  Sales and trading group act as agents for clients and also can trade the firm’s own capital.
4. Equity Research – The equity research group research or “coverage” of securities to help investors make investment decisions and support trading of stocks. They often do an extensive research on stocks and provide with reports.
5. Asset Management – Managing investments for a wide range of investors including institutions and individuals, across a wide range of investment styles. The concept is pretty similar to a hedge fund.

Investment banks’ clients include:

• Governments – Investment banks work with governments to raise money, trade securities, and buy or sell crown corporations.
• Corporations – Bankers work with private and public companies / operating businesses (known as “corporations” or “corporates”) to help them go public (IPO), raise additional capital, growth their business, make acquisitions, sell business units, provide research for them and general corporate finance advice.
• Institutions – Banks work with institutional investors who manage other people’s money (known as “institutions”) to help them trade securities and provide research.

Function of a commercial banks

A commercial bank is a financial institution that is authorized by law to receive money from businesses and individuals and lend money to them. Commercial banks are open to the public and serve individuals, institutions, and businesses.

A commercial bank is authorized to serve the following functions:

• Receive deposits - take money in from individuals and businesses (called depositors), this can be in form of current/savings account or a fixed deposit and many other types of accounts which are available in commercial banks.
• Disburse payments - make payments upon the direction of its depositors, such as honouring a check, withdrawal of cash from ATM, making online offline payments through credit/debit cards.
• Collections - a bank will act as your agent to collect funds from another bank payable to you, such as when someone pays you by check drawn on an account from a different bank
• Safeguard money - banks are considered a safe place to store your wealth
• Maintain and service savings and checking accounts of its depositors
• Maintain custodial accounts - accounts controlled by one person but for the benefit of another person, such as a trust account
• Lend money, this is one of the biggest function and main source of revenue for a commercial bank, they issue loans on houses,cars,education,marriage,business etc and earn an interest on that.

The facilities provided by commercial banks are usually used by all the people of the country by the way of savings and current account. Using a commercial bank debit/credit card is very common for a person these days. Also, car/home/education loans are mostly taken by the general people of the country. Big corporate institutions also prefer using banking finance(Corporate loans) to finance their projects sometimes.

An insurance company is A business that provides coverage, in the form of compensation resulting from loss, damages, injury, treatment or hardship in exchange for premium payments. The company calculates the risk of occurrence then determines the cost to replace (pay for) the loss to determine the premium amount. Like commercial banks, insurance companies have a big variety of clients, almost everyone uses insurance in one way of other.

For example, we take an insurance for car/health/inventory etc. in order to ensure that we get a proper compensation when a damage or loss is incurred.

Venture capital funds are the financial institutions who usually borrow money from people and then invest them into start-up ventures with good ideas and high potential to earn. They also help these start-ups to grow and scale, whenever these start-ups are successful and profitable, these venture capitalists usually take an exit by selling their shares to other institutional investors or through an IPO. Venture capital funds usually have a particular set of institutional clients.

A pension fund is a fund from which pensions are paid, accumulated from contributions from employers, employees, or both.

Public pension funds, or funds are for retirement savings of people who work for a government employer or in the public sector.

The basic idea is that, in a pension fund the employer usually contribute a certain amount of money regularly after a particular set of time and that money is then invested in some financial assets and a maintained by a fund manager to earn a return, it is also known as Assets under management(AUM), these funds are then used to pay the pensions of the employee. Pensions are the set of payments which are received by an employee after retirement.

If the same, process if followed for government employees and is monitored by the government, it is called a public pension fund.

Their main motive is to generate sufficient money to pay their client’s pensions, hence their main clients are the employees.