30th May 2024

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Business Industry and Financial

Investment Banks vs. Merchant Banks: What’s the Difference?

Investment banks and merchant banks are financial institutions that do not serve individuals or small and mid-sized businesses. Investment banks conduct trade finance activities, while merchant banks partake in international finance and underwriting activities.

Key Takeaways

  • Merchant banks provide services to international finance, business loans for companies, and underwriting.
  • Investment banking clients include institutional investors, governments, and corporations.
  • Merchant banks help companies and high-net-worth individuals.

Investment Banks

Investment banks are institutions that serve as intermediaries for large and complex financial transactions. Their clients include governments, other financial institutions, and institutional clients such as hedge funds, pension funds, and large companies.

Investment banks raise funds for businesses, governments, and municipalities by registering and issuing debt or equity and selling these investments on an open market through initial public offerings (IPOs). Investment banks traditionally underwrite and sell these securities in large blocks. Small boutique investment banking firms may narrow their focus to a small area of expertise such as mergers and acquisitions (M&A).

Investment banks may be fee-based or fund-based, earning income from interest and other leases from their clients. Some of the world’s best-known and biggest investment banks include Barclays (BCS), UBS (UBS), and Credit Suisse (CS). Many of these banks also operate smaller retail and commercial branches for the general public.

Investment banks may specialize and serve a specific sector or industry such as healthcare or energy.

Merchant Banks

Merchant banks serve high-net-worth individuals (HNWIs) and multinational corporations. Some of their primary functions include international financing and underwriting activities that include foreign corporate investing, foreign real estate investment, trade finance, and the facilitation of international transactions.

Merchant banks issue letters of credit, internationally transfer funds, and consult on trades and trading technology. They charge fees to provide advisory and other related services to their clients. Leading merchant banks include J.P. Morgan (JPM), Goldman Sachs (GS), and Citigroup (C). Like investment banks, many also have commercial and retail operations that serve individual consumers and small to mid-sized businesses.

Investment Banks vs. Merchant Banks

Investment banks focus on IPOs and large public and private share offerings. Merchant banks tend to focus on small-scale companies by offering creative equity financing, bridge financing, mezzanine financing, and several highly delineated corporate credit products.

To bridge the gap between venture capital and a public offering, larger merchant banks privately place equity with other financial institutions and take on large portions of ownership in companies that exhibit strong balance statements, solid fundamentals, and strong growth potential.

While merchant banks offer trade financing products to their clients, investment banks rarely do so because most investment banking clients have outgrown the need for trade financing and related credit products.

Investopedia / Sabrina Jiang

Do Investment Banks Provide Consulting Services?

While investment banks mainly service large companies such as major mutual fund houses, they can also provide consulting services to private investors through their private wealth management and private client services divisions.

What Is Underwriting?

An investment bank raises capital from institutional investors in the form of debt or equity in a process called underwriting.

How Did Merchant Banks Originate?

Merchant banks emerged in the Middle Ages, evolving from Italian commodity merchants, and were the first modern banks. A merchant bank historically dealt in commercial loans and investments to facilitate the production and trade of commodities.

The Bottom Line

Investment banks and merchant banks are financial institutions that do not serve individuals or small businesses, although banks may have retail locations or branches for small investors. Merchant banks facilitate international finance transactions and underwriting. Investment banks serve institutional investors, governments, and corporations.