Investment Banks vs. Merchant Banks: An Overview

Investment banks and merchant banks are different types of financial institutions that perform services that are very distinct from one another. 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.

To make sense of it all, a breakdown of the true functions of each entity includes the following broad responsibilities and characteristics.

Investment Banks

The activities of investment banks usually vary from one institution to another. Small boutique investment banking firms may narrow their focus to a small area of expertise.

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.

They also facilitate the mergers and acquisitions 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.

Examples of investment banks in today's financial world include Barclays (BCS), UBS (UBS), and Credit Suisse (CS).

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.

Traditional merchant banks primarily perform 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).

Key Differences

While both the two types of banks 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.

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

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” and “sell” ratings on various stock investments.

Merchant banks provide services to small- to mid-sized corporations and high-net-worth individuals who typically have businesses around the world. They do not, however, provide services to the general public.

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 banks have a wider range of clients, such as individuals and big companies.