Commercial banks and investment banks are two of the most important types of financial institutions, playing critical but distinct roles in the economy.

While they have some similarities, there are several key differences between these two types of banks in terms of their business models, services offered, regulations, and more.

Understanding the distinctions can provide valuable insight into the financial sector.

Key Takeaways

• While commercial banks earn income mostly from interest on loans, Investment banks rely on fees from services like underwriting and advisory work.

• Commercial banks engage in more conservative consumer lending and are more strictly regulated. Investment banks involve greater risk tolerance with trading and complex deals.

• Commercial banks operate widespread branch networks for in-person banking. Investment banks focus on centralized headquarters serving institutional clients.

• The Glass-Steagall Act previously enforced separation between commercial and investment banking. Its repeal allowed for greater consolidation of financial institutions.

• Major commercial banks include Wells Fargo, Bank of America, JPMorgan Chase, Citigroup, and online banks like Ally and Discover. Top investment banks are Goldman Sachs, Morgan Stanley, Credit Suisse, and Bank of America Merrill Lynch.

• Investment banking originated with medieval merchant banks and government securities trading. Commercial banking developed from the Bank of England and other early central banks.

• Both types of banks continue to evolve amidst trends like digitalization, globalization, competition, and changing regulations. However, their core functions facilitating key financial transactions remain intact.

What are Commercial Banks?

Commercial banks, also known as retail banks, are the type of banks that most consumers interact with in their day-to-day finances. The primary business of commercial banks is accepting deposits and providing loans to individuals and businesses. When you open a checking or savings account, apply for a mortgage or personal loan, or use banking services, you’re working with a commercial bank.

Some of the key services offered by commercial banks include:

• Checking and savings accounts
• Certificates of deposit (CDs)
• Personal loans
• Mortgages
• Credit cards
• Debit cards
• ATM access

In addition to loans and deposit accounts for consumers, commercial banks also provide services like treasury management, payroll, and lending to small and medium-sized businesses. The income commercial banks earn comes predominantly from the interest they charge on loans.

Commercial banks operate by taking in consumer deposits and then lending out those funds to other customers. This is known as fractional reserve banking. For example, when you deposit $100 into your savings account, the bank doesn’t store all of that money in its vault. Instead, they loan out a portion of it, keeping only a fraction on reserve.

What are Investment Banks?

Investment banks focus primarily on providing services to corporations, institutions, and high-net-worth individuals who need assistance with activities like raising investment capital and facilitating mergers and acquisitions. They do not take deposits and provide retail banking services like commercial banks do.

The primary functions of an investment bank include:

• Assisting companies with mergers and acquisitions (M&A)
• Underwriting debt and equity offerings
• Brokering trades for institutional investors
• Providing advisory services related to transactions, valuations, and capital structuring
• Acting as intermediaries between issuers of securities and investors
• Facilitating reorganizations, private placements, and corporate partnering activities

For example, when a company wants to issue bonds or stock to raise money, it will work with an investment bank to structure the deal and sell the securities. Investment banks connect companies with investors who want to purchase the bonds or shares being offered. For this service, they charge fees and commissions.

The three main lines of business for investment banks are investment banking, asset management, and securities trading and brokerage services. Investment banking activities produce the majority of an investment bank’s revenues.

Key Differences Between Commercial and Investment Banks

While commercial banks and investment banks both facilitate important financial transactions, they have distinct business models and focus areas:

Clients

Commercial banks serve personal consumers and businesses, while investment banks focus on larger institutions, governments, and high-net-worth individuals.

Services

Commercial banks provide deposit accounts, loans, credit cards, and other basic personal and business banking services. Investment banks do not take deposits but assist clients with things like issuing securities and facilitating mergers.

Revenue sources

Commercial banks earn income primarily through interest on loans, while investment banks earn fees through commissions and charges for services rendered.

Regulations

Commercial banks are more strictly regulated than investment banks, with rules limiting their investments and activities. The separation between the two was previously mandated by the Glass-Steagall Act.

Risk tolerance

Investment banks facilitate riskier activities like trading and complex corporate transactions. Commercial banks’ operations like deposit-taking and consumer lending are considered more risk-averse.

Ownership structure

Most commercial banks are privately owned or have public shareholders, while many investment banks are structured as partnerships.

Branch networks

Commercial banks operate large branch networks where consumers can access in-person services. Investment banks have centralized headquarters focused on serving institutional clients.

While the financial crisis blurred some of the boundaries between these two types of banks, important distinctions remain in terms of their business focus, balance sheet makeup, and client relationships. Understanding the unique roles and characteristics of commercial and investment banks provides context on the different components of the banking system.

The History of Commercial and Investment Banks

The critical functions provided by both commercial and investment banks evolved over centuries. Looking at a brief history helps explain how the banks arrived at their distinct roles.

Commercial Banking Origins

Some early precursors to commercial banking emerged centuries ago. For instance, merchants in ancient Greece and Rome provided loans to farmers and traders. However, modern commercial banking took shape in the 17th and 18th centuries.

The first recognized commercial bank opened in London in 1690. The Bank of England pioneered many central banking functions still in use today, like issuing banknotes and lending to the government. In the 1700s, commercial banking grew as banks opened across Europe to finance international trade and war efforts.

In the United States, the beginnings of commercial banking lay with the Bank of North America, established in 1781, and the First Bank of the United States chartered in 1791. State-chartered banks spread rapidly across America in the early 1800s.

Unregulated, under-capitalized state banks in the free banking era led to financial instability. This resulted in reforms like the National Bank Acts of 1863 and 1864, which created national banking charters and the dual banking system still in place today.

The Federal Reserve System was established in 1913 to bring central control over monetary policy. Important banking regulations like deposit insurance through the FDIC and Glass-Steagall followed the financial crises of the 1920s and 30s. This regulatory framework governed commercial banking for decades.

Deregulation starting in the 1970s and 80s removed many restrictions on commercial bank activities, permitting more financial services and products. The Gramm–Leach–Bliley Act in 1999 formally repealed Glass-Steagall, allowing greater integration of investment and commercial banking.

Investment Bank Origins

Investment banking has its origins in the trading of government securities in the 17th and 18th centuries. Governments relied on banks to handle the issuance and trading of government bonds to finance military campaigns and infrastructure projects.

One of the first major investment banks, Mayer Amschel Rothschild Bank, opened in Frankfurt in the late 1700s, specializing in trading and the finance of international transactions. By the 1800s, investment banks were handling large bond issues for corporations and governments around the world.

In the United States, the First Bank of the United States and the Bank of New York acted as early investment banks. However, restrictions on banking corporations limited growth until regulatory changes like the Free Banking Law of 1838.

Philip Lehman and his brothers established the merchant bank Lehman Brothers in 1850, which later grew into a prominent Wall Street investment firm financing railroads, the cotton trade, and other industries. Investments at the time were often structured as private partnerships. However, J.P. Morgan pioneered the modern corporate structure for investment banks in the late 1890s.

Major firms like Morgan Stanley, Goldman Sachs, and Merrill Lynch rose to prominence in brokering corporate securities. Government regulation like Glass-Steagall separated investment banking from commercial banking. This required firms to choose to be either a commercial bank or an investment bank. Many picked the latter, focusing exclusively on securities underwriting and corporate finance advisory services.

In the 1980s and 1990s, investment banks began offering more services to compete with commercial banks. The repeal of Glass-Steagall brought increased consolidation of major banks. The financial crisis led to the failure of storied firms like Lehman Brothers and Bear Stearns. However, investment banking remains critical for capital raising and deal-making.

Major Commercial Banks

Today, the U.S. banking system includes thousands of commercial banks, from large nationwide banks to regional and community banks. Among the largest retail banks in the country measured by assets and deposits are:

• JPMorgan Chase
• Bank of America
• Wells Fargo
• Citigroup
• U.S. Bank
• PNC Bank
• TD Bank

These massive banks operate thousands of branches and manage trillions in assets across retail, business, credit card, mortgage, and other lines of business. Regional banks like PNC and TD have assets over $400 billion and national reach through robust branch networks and digital banking capabilities.

In addition to these brick-and-mortar retail banks, some of the largest commercial banking institutions with significant deposit market share include:

• Ally Bank
• Discover Bank
• American Express National Bank
• Goldman Sachs Bank USA
• Synchrony Bank

These direct and online banks operate digitally without physical branches. They attract consumer deposits by offering high-yield savings products and charge lower overhead expenses.

The U.S. commercial banking sector also consists of thousands of smaller regional and community banks that focus on serving local markets and businesses. While they lack the scale of trillion-dollar banks, these smaller institutions account for a substantial portion of loans to individuals and SMEs.

Major Investment Banks

Today’s investment banking sector is dominated by a handful of elite “Bulge Bracket” firms like:

• Goldman Sachs
• Morgan Stanley
• JPMorgan Chase
• Bank of America Merrill Lynch
• Citigroup
• Credit Suisse
• Barclays
• Deutsche Bank

These massive global institutions work on IPOs, mergers, fundraising, and other high-stakes deals for corporations, governments, hedge funds, private equity firms, and ultra-high-net-worth people. Their investment banking fees can run into the hundreds of millions on a single transaction.

In addition to these giants, numerous mid-market or “Middle Market” investment banks provide expertise in M&A, capital raising, and other services for small and mid-sized companies. These include firms like:

• Lazard
• Evercore
• Piper Sandler
• William Blair
• Jefferies
• Stifel
• Robert W. Baird
• Cowen

While they lack the global scale of the bulge bracket, these investment banks fill an important niche – especially as smaller companies pursue growth. There are also many boutique investment banks and advisory firms specializing in specific industries and services.

The Future of Banking

Both commercial and investment banking continue to evolve. Ongoing trends like digitalization, globalization, competition from fintechs, and shifting regulations will impact these financial institutions. Yet it’s likely that both commercial banks supporting consumer banking needs and investment banks enabling complex institutional transactions will remain pillars of the banking ecosystem. Though their business models diverge, they provide complementary financial services vital for economic growth and prosperity.

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