Behind the Scenes: What Do Wall Street Banks Actually Do?

When you think of banks, visions of everyday personal banking transactions might pop up. However, Wall Street banks operate on a much grander scale, engaging in activities that are both vast and complex. Contrary to popular belief, the fundamental operations of these banks are not entirely different from those of your local bank. Instead, Wall Street banks simply handle much larger sums of money, dealing with massive loans and investments. This article delves into the actual functions of Wall Street banks and how they operate on a larger scale.

Basic Banking Functions

At their core, Wall Street banks, like any other bank, engage in the most basic financial activities of loaning money and borrowing money. People apply for loans from banks to meet their needs, and in return, they are charged interest. Conversely, individuals can deposit their savings into a bank to earn interest. The bank makes a profit by charging more on loans than it pays in interest to investors. This difference, known as the 'spread,' is the backbone of the bank's profit margin.

Complicated Financial Investments

While some financial investments may seem overly complex, at their essence, they still revolves around the basic principle of loaning and borrowing money. Take the stock market, for instance. Companies sell small portions of their ownership in the form of stocks to raise capital. In exchange, stockholders receive a share of the company's profits, known as dividends. This mechanism is designed to attract both individuals and larger institutions to invest in the company.

Dealing with Large Sums of Money

Unlike your local bank, which primarily caters to individual customers seeking relatively small loans, Wall Street banks handle much larger sums of money. They provide loans to large corporations and facilitate borrowing from large groups of investors as well as affluent individuals. Consequently, institutions and wealthy individuals who require substantial loans often seek out Wall Street banks.

The Role of Underwriting

Why are Wall Street banks considered the top choice for those in need of significant funds? One reason is that they specialize in 'underwriting.' This process involves agreeing to sell new stocks or bonds to investors on behalf of companies or organizations. Wall Street banks guarantee a certain amount of money and then sell the securities for a higher price, retaining the difference as a fee.

Real-World Examples

Let's consider a venture capital firm in need of additional funding. They may not be able to raise enough money through their current resources to finance further growth. In such a case, they can approach a Wall Street bank to underwrite a stock issue. By diluting their share of the initial investment, they can sell the remaining shares to the public, thereby securing the necessary capital for business expansion.

For another example, imagine a major automobile manufacturer needing funds to construct a new factory. Instead of seeking funds independently, they might turn to a Wall Street bank to underwrite a bond issue. The bank would then sell these bonds to individual and institutional investors, providing the company with the capital it needs for its expansion.

Concentration and Expertise

Wall Street, especially New York City, houses the largest concentration of merchant banks within the United States. The area is renowned for its expertise and vast resources. Apart from New York, Boston and San Francisco also have significant merchant banks, but the density and expertise of Wall Street make it a prime destination for those seeking substantial financial support.

Conclusion

In summary, while Wall Street banks operate on a significantly larger scale and cater to the financial needs of large corporations and individuals, their core functions are essentially the same as those of any other bank. The key difference lies in the scale of the transactions they handle and the services they provide. Whether you're a small business owner considering a personal loan or a large corporation in need of vast financial resources, understanding the role of Wall Street banks can provide valuable insights into the financial ecosystem.