What Is the Difference Between an Investment Bank & a Bank Holding Company?
Bank holding companies and investment banks are distinctly different entities that serve separate purposes. A bank holding company controls or owns one or more banks. An investment bank serves as agent or underwriter that is an intermediary between people who invest in securities and companies that issue securities.
Bank Holding Companies
Bank holding companies governance is under Federal Deposit Insurance Corp. (FDIC) Act 6000. The act has a lengthy definition of bank holding company, but the main point is that a bank holding company exerts control over one or more banks. The act does restrict thrift and state-chartered banks from acting as bank holding companies.
Investment Bank
The name investment bank is a bit misleading in that the company is not typically a bank that provides retail banking services to the public. Investment bankers are investment brokers who deal with merger and acquisitions, in addition to securities underwriting. Typical clients for investment banks are institutions and consumers seeking use of an investment banker for brokerage services.
Comparison
During the economic downturn of 2008, many investment banks suffered tremendous financial setbacks. This caused investment banks such as Goldman Sachs and Morgan Stanley to convert from investment banks to bank holding companies. Investment banks are not subject to strict regulatory requirements that apply to bank holding companies, and can make risky investments with little capital on hand. Bank holding companies are restricted with regards to the type of debt and risk the company can have, and investment banks converting to bank holding companies did so to have access to federal funding.
Regulatory Governance
Bank holding companies are subject to many levels of government regulation, including the FDIC and the Office of the Comptroller of the Currency (OCC). Investment banks prior to 2008 received Securities and Exchange Commission oversight, but the SEC received severe criticism not properly monitoring investment banks and ended the program. Investment banks are still required to file regular financial reports with the SEC.
- National Information Center: All Institution Types Defined
- FDIC: FDIC Law, Regulations, Related Acts
- The Free Dictionary: Investment Bank
- The Free Dictionary: Bank Holding Company
- ProPublica: Why is Everyone Becoming a Bank Holding Company? It’s All About the Benjamins; Kristin Jones, Nov 12 2008
- Office of the Comptroller of the Currency: ABout the OCC
Mary Frazier began writing in 2011 for various websites and has over 20 years of experience as a bank vice president and senior trust officer. Frazier is a Certified Trust and Financial Advisor, holds a Bachelor of Arts in economics from the University of North Florida and holds a Master of Science in finance from the College for Financial Planning.
Hedge Funds vs. Investment Banks: What’s the Difference?
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For many people, hedge funds and investment banks are both terms that are synonymous with rich people, but the differences between the two are significant. A hedge fund manages a highly diverse investment portfolio that aims to generate outsized returns. They invest accordingly, then sell shares in their portfolios to third parties. They make money off their portfolios’ returns. An investment bank manages finances for their clients, helping companies raise capital and managing complex transactions for both buyers and sellers. They make money off fees they charge clients.
For help with investing questions, you may want to consider working with a financial advisor.
What Is a Hedge Fund?
A hedge fund is a portfolio-based investment product. The fund itself invests in a number of different assets, and the portfolio generates returns based on the collected returns of those underlying holdings. Outside investors can then buy shares in this portfolio, the same way that you can buy shares of a mutual fund or an ETF, and they make money based on their proportional ownership of the overall fund.
A hedge fund makes its money off a combination of fees and the capital appreciation of portfolios. One way is through fees. Hedge funds will charge their clients to invest in the portfolio, and these fees represent the work that goes into actively managing the fund. The firm will generally take both a flat fee (for example, you might pay an annual fee worth 2% of your total holdings) as well as a proportion of returns (for example you might also owe 10% of your portfolio’s profits each year).
Hedge funds can invest in an extremely wide variety of assets. They are privately traded, meaning that they are subject to relatively little SEC oversight, and they can only take money from institutions and accredited investors. This allows them to invest in virtually any legal financial product or asset. While a hedge fund’s portfolio will often include mainstream assets like stocks and bonds, they will also frequently invest in more high-risk assets like startup companies, speculative real estate, derivative securities, emerging technology, art, short sales and commodities.
Typically hedge funds will invest around a theme. For example, you might invest in a technology-oriented hedge fund that makes high-tech investments or a real estate hedge fund that seeks out good property deals. The goal of a hedge fund is to build an investment portfolio that outperforms the market. They seek large returns, but in doing so accept larger risks.
What Is an Investment Bank?
An investment bank, which is different from a commercial bank, is a financial institution that helps companies and clients manage large-scale financial transactions. Two well-known investment banks are Morgan Stanley and Goldman Sachs. Their work generally takes two forms:
- Buyer’s side: Here the bank helps institutions and individuals that are looking to make large investments or otherwise manage large amounts of capital.
- Seller’s side: Here the bank helps institutions and individuals looking for large amounts of capital, such as by selling investment products or debt notes.
Investment banks generally do business with large organizations, such as companies and brokerages. They do, on occasion, work with particularly high net-worth individuals, but only when large amounts of capital are involved.
An investment bank differs from what is known as a “depository bank” in that it doesn’t hold money on behalf of individuals, such as in a checking or savings account. Instead, it helps clients exchange financial products, and the bank makes its money off the fees and commissions it charges for this service. For most of the 20th century investment banks were entirely barred from acting as depository banks, at least for non-accredited individuals. This law was partially repealed in November 1999.
Examples of the kind of work an investment bank will do include:
Issuing Stock
When a company wants to launch an initial public offering (IPO), that is, go public, it will hire an investment bank to conduct the review and oversight process and to find initial buyers for the company’s stock. An investment bank will conduct a similar process when one of its clients wants to issue additional shares, conducting the necessary financial audits and selling the shares to new investors.
Bond Issuance
Investment banks will help institutions raise money through debt by issuing bonds. As with helping companies sell their stock, this involves conducting the necessary financial oversight and finding investors to buy the bonds. An investment bank will help firms to merge, acquire each other or otherwise conduct large-scale stock transactions.
Portfolio Management and Stock Sales
Investment banks will often manage the portfolios of large private clients. For example, a company might deposit its employees’ retirement funds with an investment bank to manage the 401(k) portfolios. Another firm might hire an investment bank to help it buy back shares of its stock or to help sell shares of its stock on the secondary market.
Creating and Selling Secondary Products
Many investment banks will create what are known as secondary financial products. These are generally derivatives, assets that take their value from some other security or financial product. (For example, an options contract is a derivative because it gives you the right to buy or sell some underlying asset and takes its value from that right.) Investment banks will create these products and sell them, almost always to other institutional investors.
To be clear, this is a representative sample of the kind of work that investment banks do. Overall, their function is to help institutions raise and invest large amounts of capital. This is in many ways similar to how depository banks help individuals hold, raise and manage money.
The business model of an investment bank differs from a hedge fund in several ways but perhaps the most important is that the business model of a hedge fund is to make investments and profit off their returns. The business model of an investment bank is to provide financial services to clients and profit from the fees it charges. A hedge fund offers the product that high-net-worth investors purchase. An investment bank offers the services for how they can invest.
Bottom Line
A hedge fund offers people the chance to invest in a portfolio, with returns based on how well the portfolio’s underlying investments do. The fund itself makes most of its money from the fees and commissions that it charges based on those returns. An investment bank helps clients make large-scale financial transactions and makes its money off the fees it charges for this service.
Investing Tips
- If you have questions about managing an investment portfolio, a financial advisor may be able to help. Finding a financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with up to three vetted financial advisors who serve your area, and you can have a free introductory call with your advisor matches to decide which one you feel is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
- If you want to understand the nature of investment banking, almost nothing is more important than learning about the history of the 1934 Securities Exchange Act and the 2010 Dodd Frank Act.
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Eric ReedEric Reed is a freelance journalist who specializes in economics, policy and global issues, with substantial coverage of finance and personal finance. He has contributed to outlets including The Street, CNBC, Glassdoor and Consumer Reports. Eric’s work focuses on the human impact of abstract issues, emphasizing analytical journalism that helps readers more fully understand their world and their money. He has reported from more than a dozen countries, with datelines that include Sao Paolo, Brazil; Phnom Penh, Cambodia; and Athens, Greece. A former attorney, before becoming a journalist Eric worked in securities litigation and white collar criminal defense with a pro bono specialty in human trafficking issues. He graduated from the University of Michigan Law School and can be found any given Saturday in the fall cheering on his Wolverines.
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