Investment banking and commercial banking are two divisions of the banking industry that provide 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). Commercial banks act as managers for deposit accounts for businesses and individuals, although they are primarily focused on business accounts, and they make public loans through deposit money that they hold.
Since the major economic downturn beginning in 2008, a number of entities that mix investment banking and commercial banking have fallen under intense scrutiny, being looked at as the source of the downward trend. There is a great debate over whether the two divisions of the banking sector should operate under one roof, or if the two are best kept separate.

Federal Regulation

Commercial banks are highly regulated by a variety of federal authorities, such as the Federal Reserve and the Federal Deposit Insurance Corporation (FDIC). Commercial banks are insured by the federal government, maintaining an ability to protect customer accounts and provide a certain level of security. Investment banks differ, as they are much more loosely regulated by the Securities and Exchange Commission (SEC). This offers less protection to customers, but allows investment banks a significantly greater amount of operational freedom.

The comparative weakness of regulation by the government, along with their specific business model, does give 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 ways that keeps their clients' best interests in mind. The greater level of government control on commercial banks also decreases their levels 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 occurring 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However, Glass-Steagall was largely repealed in the 1990s.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 been able to engage in both types of banking under the same roof. Despite the legal freedom to expand operations, most of the largest U.S. banking institutions have chosen to remain operating as either a commercial or an investment bank, just as they were before the repeal of Glass-Steagall.

Benefits for Combination Banks

There are some benefits to the combination of the functions of investment banks and commercial banks. 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, enabling the business to finance rapid growth and consequent increases its stock price. The combination bank can then additionally glean the benefits of increased trading in the form of commission revenue.

  1. How does investment banking differ from commercial banking?

    Discover how investment banking differs from commercial banking, the responsibilities of each and how the two can be combined ... Read Answer >>
  2. How do investment banks help the economy?

    Learn more about the functions of investment banks in a modern economy and how investment banks have been treated differently ... Read Answer >>
  3. What is the banking sector?

    Why the banking sector is a vital industry, what it does to drive economic growth and examples of companies in this sector. Read Answer >>
  4. What are The Nine Major Financial Institutions?

    There are nine major types of financial institutions. Understand these major types of financial institutions that exist in ... Read Answer >>
  5. What is the average profit margin for a company in the banking sector?

    Learn what the average profit margin is for companies in the banking sector, along with other evaluation metrics often used ... Read Answer >>
Related Articles
  1. Insights

    The Role of Commercial Banks in the Economy

    We interact with commercial banks daily to carry out simple financial tasks. That said, the function and creation of a commercial bank is anything but simple.
  2. Personal Finance

    Retail Banking vs. Corporate Banking

    Retail banking is the visible face of banking to the general public. Corporate banking refers to the aspect of banking that deals with corporate customers. Check out more on the differences between ...
  3. Insights

    A Brief History of U.S. Banking Regulation

    From the establishment of the First Bank of the United States to Dodd-Frank, American banking regulation has followed the path of a swinging pendulum.
  4. Insights

    Central Bank

    They print money, they control inflation, they are known as the "lender of last resort". Check out the role of Central Bank nd how its role evolved overtime.
  5. Investing

    What Was The Glass-Steagall Act?

    Established in 1933 and repealed in 1999, the Glass-Steagall Act had good intentions but mixed results.
  6. Small Business

    When Wholesale Funding Goes Bad

    The wholesale funding process is extremely dependent on the credit markets. Find out why it is not always the best option for a business.
  7. Financial Advisor

    Why Banks Don't Need Your Money to Make Loans

    Contrary to the story told in most economics textbooks, banks don't need your money to make loans, but they do want it to make those loans more profitable.
  8. Investing

    Citadel's Billionaire Griffin Argues for a New Glass-Steagall

    Illinois' richest man said that it is his “fantasy” to break up big banks and that he would like to see a new Glass-Steagall Act.
  1. Glass-Steagall Act

    The Glass-Steagall Act was passed by the U.S. Congress in 1933 ...
  2. Bank

    A bank is a financial institution licensed as a receiver of deposits. ...
  3. Business Banking

    Business banking is a company's financial dealings with an institution ...
  4. State Bank

    A state bank is a financial institution, which a state has chartered ...
  5. Chain Banking

    Chain banking is a form of bank governance that occurs when a ...
  6. Deregulation

    The reduction or elimination of government power in a particular ...
Hot Definitions
  1. Liquidity

    Liquidity is the degree to which an asset or security can be quickly bought or sold in the market without affecting the asset's ...
  2. Federal Funds Rate

    The federal funds rate is the interest rate at which a depository institution lends funds maintained at the Federal Reserve ...
  3. Call Option

    An agreement that gives an investor the right (but not the obligation) to buy a stock, bond, commodity, or other instrument ...
  4. Standard Deviation

    A measure of the dispersion of a set of data from its mean, calculated as the square root of the variance. The more spread ...
  5. Entrepreneur

    An entrepreneur is an individual who founds and runs a small business and assumes all the risk and reward of the venture.
  6. Money Market

    The money market is a segment of the financial market in which financial instruments with high liquidity and very short maturities ...
Trading Center