What It Is:
An investment bank is a financial intermediary that specializes primarily in selling securities and underwriting the issuance of new equity shares to raise capital funds. This is different from a commercial bank, which specializes in deposits and commercial loans.
How It Works/Example:
Investment banks mediate between companies that issue securities and the individuals or entities wishing to purchase them. In this respect, investment banks operate along two main lines: a "buy" side and a "sell" side. "Buy" side operations include services such as securities trading and portfolio management. "Sell" side activities include underwriting new lines of stock, marketing financial products, and publishing financial research.
To illustrate an investment bank's “buy side” role in securities trading, suppose an investor wants to purchase 100 shares of company XYZ. They can solicit the services of an investment bank, where a stock broker can place an order and deliver these shares.
To illustrate an investment bank's “sell side” role as an underwriter, suppose company XYZ plans to issue new shares of stock in an initial public offering (IPO) XYZ can solicit an investment bank to underwrite the shares, market and sell them to their clients. This way, the investment bank raises the funds that company XYZ hopes to gain from the issue of the new shares.
Regulation becomes a key issue for investment banks, because they operate on both (and often competing) sides of the same coin. Consequently, there is significant room for conflicts of interest between the buying and selling operations. Agencies such as the SEC provide strict guidelines to help ensure that operations on the "buy" and "sell" sides do not intersect and result in unfair market practices or ethics violations.
Why It Matters:
Investment banks bring investors together with companies that issue securities and broker securities. Investment banks are also beneficial to security-issuing companies, because, while they broker the securities a company may issue, they can help raise capital funds for such companies through underwriting new stock offerings.