Investment Banks vs. Merchant Banks: An Overview

Investment banks and merchant banks are different types of financial institutions. These banks do not serve consumers—individual clients or small and mid-sized businesses. Some of the services they provide are the same including underwriting and investment services. But the fine line that theoretically separates the functions of these two institutions tends to blur, as the activities often bleed into one another’s territories. Investment banks conduct trade finance activities while merchant banks take part in international finance and underwriting activities.

Key Takeaways

  • Merchant banks lend their services to international finance, business loans for companies, and underwriting.
  • Investment banking is usually fee- or fund-based, providing a wider variety of services to its clients.
  • Merchant banks help companies and high-net-worth individuals.
  • Investment banking clients include institutional investors, governments, and corporations.

Investment Banks

Investment banks are institutions that serve as intermediaries for a variety of purposes. Their activities usually vary from one institution to another. Most of the services in which they engage tend to be large and complex financial transactions. Investment banking clients are normally governments and other financial institutions as well as institutional clients such as hedge funds, pension funds, and large companies.

Pure investment banks are chiefly responsible for raising funds for businesses, governments, and municipalities by registering and issuing debt or equity and selling these investments on an open market through initial public offerings (IPOs). Investment banks traditionally underwrite and sell these securities in large blocks. Small boutique investment banking firms may narrow their focus to a small area of expertise. They also facilitate mergers and acquisitions (M&A) of companies through share sales and provide research and financial consulting to companies.

Investment banks may be fee-based because they provide banking and advisory services. They may also be fund-based because they can earn income from interest and other leases from their clients.

Some of the world's best-known and biggest investment banks include Barclays (BCS), UBS (UBS), and Credit Suisse (CS).   Many of these banks also operate smaller retail and commercial branches for the general public.

While investment banks focus on larger companies, merchant banks offer their services to corporations that are too large for venture capital firms but small enough to make a compelling public share offering on a large exchange.

Merchant Banks

Just like investment banks, the precise list of offerings differs depending on the merchant bank in question. Interestingly, the term merchant bank was the British term used to describe investment banks.

Merchant banks don't deal with the general public, so they don't take deposits or make withdrawals. Instead, they serve high-net-worth individuals (HNWIs) and multinational corporations. Some of their primary functions include international financing and underwriting activities. These may include—but aren't limited to—foreign corporate investing, foreign real estate investment, trade finance, and the facilitation of international transactions.

Merchant banks may be involved in issuing letters of credit, internationally transferring funds, and consulting on trades and trading technology. These banks earn money from fees because they provide advisory and other related services to their clients.

Several of today's leading merchant banks include J.P. Morgan (JPM), Goldman Sachs (GS), and Citigroup (C). Just like investment banks, many of these banks also have commercial and retail operations that serve individual consumers and small to mid-sized businesses.

Key Differences

There's a fine line between merchant and investment banks. While both operate within the financial realm, there are some key overall distinctions. As a general rule, investment banks focus on IPOs and large public and private share offerings. Merchant banks tend to focus on small-scale companies by offering creative equity financing, bridge financing, mezzanine financing, and a number of highly delineated corporate credit products.

In order to bridge the gap between venture capital and a public offering, larger merchant banks tend to privately place equity with other financial institutions and, in the process, often take on large portions of ownership in companies they believe exhibit strong balance statements, solid fundamentals, and strong growth potential.

While merchants offer trade financing products to their clients, investment banks rarely do so because most investment banking clients have outgrown the need for trade financing and the various credit products linked to it.

Special Considerations

While investment banks mainly service large companies such as major mutual fund houses, they can also provide consulting services to private investors through their private wealth management and private client services divisions. The research provided typically contains buy, sell, and hold ratings on various stock investments. Merchant banks provide services to corporations and high-net-worth individuals who typically have businesses around the world.