Investment banks and commercial banks represent two divisions of the banking industry, and each type of bank provides substantially different services. Investment banks expedite the purchase and sales of bonds, stocks, and other investments and aid companies in making initial public offerings (IPOs) when they first go public and sell shares. Commercial banks act as managers for deposit accounts belonging to businesses and individuals although they are primarily focused on business accounts, and they make public loans through deposit money that they hold.
Since the financial crisis and economic downturn beginning in 2008, a number of entities that mixed investment banking and commercial banking have fallen under intense scrutiny. There is substantial debate over whether the two divisions of the banking sector should operate under one roof or if the two are best kept separate.
Commercial banks are highly regulated by federal authorities such as the Federal Reserve and the Federal Deposit Insurance Corporation (FDIC). Commercial banks are insured by the federal government to maintain protection for customer accounts and provide a certain level of security. Investment banks differ because they are much more loosely regulated by the Securities and Exchange Commission (SEC). The Commission offers less protection to customers but allows investment banks a significantly greater amount of operational freedom.
The comparative weakness of government regulation along with the specific business model gives investment banks a higher tolerance of, and exposure to, risk. Commercial banks, on the other hand, have a much lower risk threshold. Commercial banks have an implicit duty to act in their clients' best interests. Higher levels of government control on commercial banks also decrease their level of risk tolerance.
The Glass-Steagall Act
Historically, institutions that combine commercial and investment banking have been seen in a negative light. Some analysts have linked such entities to the economic depression that occurred in the early part of the 20th century. In 1933, the Glass-Steagall Act was passed and authorized a complete and total separation of all investment and commercial banking activities.
However, Glass-Steagall was largely repealed in the 1990s. Since that time, banks have engaged in both types of banking. Despite the legal freedom to expand operations, most of the largest U.S. banking institutions have chosen to operate as either a commercial or an investment bank.
Benefits for Combination Banks
There are some benefits for banks that combine the functions of investment and commercial services. For example, a combination bank can use investment capabilities to aid a company in the sale of an IPO and then use its commercial division to offer a generous line of credit to the new business. This enables the business to finance rapid growth and, consequently, to increase its stock price. A combination bank additionally gleans the benefits of increased trading, which brings in commission revenue.