Free «The Investment Banking Business Model and Financial Stability» Essay Sample

Financial institutions play a critical role in the control and regulation of financial stability in the economy. The central bank regulates the money supply in the economy through the manipulation of interest rates. An increase or a decrease in the money supply leads to the alteration of interest rates in the economy. High interest rates discourage borrowing, which reduces the money supply in the economy. On the other hand, a decrease in interest rates encourages investors to borrow more money, which increases the money supply in the economy. There are two major branches in the banking sector that fulfil different functions: investment banking and retail banking. This paper critically analyses the investment and retail banking models as well as financial stability (Leaven & Ratnovski, 2014).

The Investment Banking Model

The banking sector is one of the major participants in the process of investment within an economy. Borrowers and depositors allow institutions within the business sector to conduct their operations. A stable banking sector enhances and promotes a given economy by offering incentives. Therefore, investment banking entails proving investment capital to investors through credits. Investment banking mainly focuses on institutions rather than individual clients. Investment banks exist to serve and cooperate with institutions as their major clients. In addition, they offer advisory roles in matters related to the economy and the general investment regarding capital market (Beck, De Jonghe, & Schepens, 2013).

The investment banks’ advisory and monetary services and their approaches enhance the economy as a whole. When a corporation or an institution is in need of accessing additional capital for their business operations, investment banks underwrite securities offered on behalf of an organization or business entity that requires funds. Investment banks play an important role in the economy because they offer financial advice regarding the current capital market conditions, market trends, corporate finance, mergers, and acquisition.

The major source of the investment banks’ profits is the fee income negotiated as a part of capital markets transactions. Every investment bank tries to lead and dominate the financial market. The major key competitive areas in the sector are the presence in capital markets, reputation, fee income, the size and scale of transactions involved, and the organizations investment banks cooperate with (Borio, 2014).

The Retail Banking Model

Retail banks play a critical role in the economy as well. They offer financial services at individual levels. They mainly focus on taking deposits and giving loans to individual clients. In addition, they provide auxiliary banking services like safe deposits boxes and payment services. When providing such services, retail banks do not target only businesses and organizations. One of the major characteristics of the retail banking model is the presence of local branches and automated tellers. The retail banks’ customers are mainly individual clients, small and medium enterprises, and small family businesses. Their depository activities mainly include offering saving accounts, checking accounts, and certificate deposits. Retail banks mainly focus on personal credits, such as vehicle loans, home mortgages, and other consumer services.  Retail banks make money by charging fees and income from loan interest. The key drivers in the retail banking sector entails deposit growth, leveraging technology to grow the customer base (Smets, 2013).

Banking Models and Financial Stability

The banking sector has two major types of customers: those who deposit and those who borrow money from financial institutions. The banking sector plays intermediary roles between borrowers and depositors in the economy. The business model in the banking sector entails low interest rates to depositors and higher interest rates to borrowers. Profit is generated from interest rate differences (Rey, 2015).

People tend to keep their financial resources in financial institutions. This is a rational decision since the money they deposit earns interest rates, unlike the money people keep at home. However, individuals have to trust financial institutions or banks with their money. On the other hand, potential customers may want to borrow money from banks at some point. For this purpose, banks offer loans at higher interest rates than the rate of interest earned by deposits (Dembiermont, Drehmann, & Muksakunratana, 2013).

Financial institutions introduce multiple channels to reach out to their clients. They open branches in different cities and at convenient locations to attract more clients. The government usually controls the banking industry. The central bank usually implements and regulates monetary policies within an economy.

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The government, through the central bank, has a mandate of controlling the money supply and demand in the economy. The central bank, in its turn, develops monetary policies to bring balance to the economy. The money supply is essential in devising the most rational measures in the economy. Central banks regulate the money supply in the economy through interest rates and other banks (Haldane, 2013).  

The government can use investment banking to bring financial stability to the economy. An increase in the money supply can lead to the alteration of interest rates in the economy as a whole.  An increase in the money supply triggers an increase in the interest rates for the investment loans offered. Such an approach may help to regulate the money supply in the economy. Higher interest rates, on the other hand, discourage borrowing from banks, which reduces the money supply in the economy.

Alternatively, the government can use the investment banking sector to bring financial stability to the economy during a deflation season. When there is a low money supply in the economy, investment banks by means of the central bank’s regulations may lower lending interest rates. As a result, business entities are able to access loans at lower prices. Thus, monetary policies and regulations help to achieve financial stability in the economy (Laeven & Ratnovski, 2014).

The central bank regulates investment banks through interest rates, just like in the case of the retail banking sector. An increase in the money supply normally leads to the central bank raising interest rates in an attempt of discouraging further borrowing from investors. Consequently, a decrease in the money supply leads to the encouragement of the investment in the economy through offering loans with low interest rates, which encourages the development of the economy (Brunnermeier & Sannikov, 2014).

In conclusion, the role of the banking sector in any economy is quite critical. The government regulates the banking sector through the central bank. The central bank, in its turn, regulates the activities of both retail and investment banks through interest rates. Higher interest rates discourage borrowing, which lowers the money supply in the economy. On the other hand, a decrease in interest rates by the central bank and the investment banking sector encourages borrowing, hence raising the money supply in the economy.