4.2 Comercial Banks and investment banks

Functions of an investment bank

Underwriting securities, facilitating mergers and acquisitions and financial advice

Explain underwriting securities

Investment banks help firms to raise capital via equity.

The investment banks acts as an underwriter, guaranteeing a price for an IPO

How do investment banks make profits

Underwriting → get a discounted price at IPOs and sell to public at a higher price

M&A → fees as a percentage of the transaction value

Asset management

Trading and sales

Difference between comercial banks and investment banks

CB - for general public

IB - for large corporations

CB - highly regulated and low risk

IB - weaker regulation and high risk

CB - savings, deposits, loans

IB - underwriting, trading, advice and M&A

Functions of comercial banks

Facilitate savings/deposits

Loan money(thereby create money)

Payment services

Assets =

Liabilities + equity

examples of assets of a comercial bank

Cash

Balances at the BoE

Securities/bonds/shares

Loans/advances

Fixed assets eg buildings

Order from most to least liquid

Buildings, cash, money from interbank lending, T bils, advances/loans, shares, bonds, balances at BoE

Cash

Balances at BoE

Money from interbank lending

T bills

Shares/bonds

Advances/loans

Buildings

Difference between t bills and bonds

T bills short term, Bonds long term

Examples of liabilities on a comercial bank balance sheet

Deposits from savers

Short term borrowing (interest bank)

Long term borrowing by the bank

Capital (retained profit and share capital)

Objectives of a comercial banks

Liquidity, profitability and security

Conflict between liquidity and profitability

Low liquidity → generate profitability

High liquidity → more cash → less profitable returns

Why is sufficient liquidity important

Meet deposit withdrawal demands

Relationship between liquidity, security and profitability

High liquidity → high security → low profitability

Why is there a conflict between security and profitability

Higher security → lower risk → lower returns → lower profitability

How do comercial banks create credit

Create credit → loan out money → money multiplier effect → money is spent and ends up deposited in back accounts → chain reaction of lending → by the fractional reserve system → only some of the deposits held by banks need be kept as liquid reserves and lend the rest