How do investment banks make money?
Investment banks generate revenue from several distinct sources, which is one reason they are often seen as well-diversified businesses across market cycles:
1. Advisory fees
Charged as a percentage of deal value for M&A and other strategic transactions. These fees can be substantial on large deals but are lumpy and hard to predict.
2. Underwriting fees
Earned when helping a company or government issue new equity or debt securities. The bank takes a fee (spread) for distributing the securities to investors.
3. Trading revenue
From buying and selling securities on behalf of clients (agency trading) or for the bank’s own account (principal trading). This can include equities, bonds, currencies, commodities and derivatives.
4. Net interest income
Earned on the difference between interest paid on deposits and charged on loans, most relevant for banks with significant commercial banking operations.
5. Asset management fees
Charged as a percentage of assets under management (AUM) for managing investment portfolios. This is a recurring, more predictable revenue stream than advisory or trading.
6. Prime brokerage
Fees charged to hedge funds for services including leverage, securities lending, clearing and custody.
The mix of these revenue streams varies significantly between banks. Goldman Sachs and Morgan Stanley have historically been more reliant on markets and advisory revenue, while JPMorgan Chase benefits from its large consumer banking operation alongside its investment bank. Investors considering financial sector ETFs or individual bank stocks should understand which revenue mix they are getting exposure to.
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