Investment banks generally fall into three groups, the very large “bulge bracket” banks, specialist firms that specialize in one or two industries, and small broker-dealers, who trade securities for their own benefit or for customers. Full-service investment banks usually provide both advisory and financing services, as well as the sales, market making, and research on a broad array of financial products including equities, credit, rates, currency, commodities, and financial derivatives. It is very common for one bulge bracket bank to be competitive in investment banking, commercial banking, asset management, private equity, venture capital, mortgage finance, and more. Investment bank clients include corporations, other financial institutions, pension funds, government agencies, and hedge funds.
Most investment and commercial banks have a financial holding company structure, which serves as a shell corporation that issues common stock, the bank’s equity capital, financing the bank’s activities. The bank’s equity capital also serves as a financial backup in the event of any write-offs from bad loans or investments. Below is a list of the 10 largest U.S. bank holding companies and their location as of March 31, 2019, according to the Federal Reserve Board.
As a result of deregulation, investment banks have become more like commercial banks and commercial banks more like investment banks. This transformation came about through enabling legislation, the Financial Modernization Act (also called the Gramm-Leach-Bliley Act) of 1999, which gave the legal okay for investment banks and insurance companies to affiliate with commercial banks. Financial holding companies are overseen by the Federal Reserve, the federal agency overseeing activities of bank holding companies and banking subsidiary companies. Non-bank subsidiaries are subject to functional regulation. For example, the Securities and Exchange Commission oversees a banking company’s broker-dealer subsidiary. By regulation, a financial holding company must have at least 85 percent of its assets in financial services; they have to divest all non-financial services within 10 years of the date they switch to a financial holding company.
Investment banks are typically split up into three distinct parts: the front office, middle office, and back office. The front office is where the bank generates its revenue. It has three primary divisions: investment banking (I-bank), sales and trading, and investment research. Investment bankers in the I-bank division help clients raise money in the capital markets. They also advise clients on financial topics like stock buybacks, mergers and acquisitions, and corporate restructurings. The sales and trading division is where an I-bank buys and sells products (stocks, bonds, commodities, foreign exchange, and so on). Traders in the sales and trading division act on the bank’s account, using the firm’s capital to place bets where they see opportunities to make money or acting on client instructions. Research is where the bank reviews companies and industries. Research analysts write reports on expected earnings in companies and the industries they follow. Other front-office divisions cover related activities, such as commercial lending, merchant banking, investment management, and global transaction banking.
The middle office typically covers financial risk controls and reporting. There is a significant level of interaction between middle and front offices to make sure the bank’s trading and underwriting activities aren’t putting too much of the bank’s capital at risk. Typical middle office activities include compliance, financial control, corporate strategy, corporate treasury, and risk management.
The back office is the unseen but vitally important section of the I-bank, providing securities settlement and record keeping services so front office bankers can do their jobs and make money for the bank. The back office provides operational and information technology support to the front and middle office parts of the bank.