How banking works: The difference between Lehman and your local bank
Morning commuters walk past the Lehman Brothers headquarters in 2008.
While retail banking and investment banking share many characteristics, they differ from each other in one important way – complexity.
Investment banks – of which Lehman was one – typically assist individuals, corporations and governments in raising capital and acting as a client’s agent in the issuance of securities.
Full service investment banks are typically involved in the following roles:
- Leveraged finance, which includes issuing high-yield debt to finance acquisitions and other corporate activities.
- Mergers and acquisitions: advising on the sales, mergers and purchases of companies.
- Equity capital markets, which typically involves IPOs (initial public offerings of shares) capital raises, and secondary offerings.
- Debt capital markets, which includes advice on the raising and structuring of debt to finance acquisitions and other corporate activities.
- Restructuring, which involves improving the structures of a company to make it more profitable or efficient.
There are also “boutique investment banks” that specialise in one activity or one industry.
Retail banking, by contrast, involves taking deposits and advancing loans, dealing with the personal, small business, farming, non-profit, corporate and government sectors.
It also involves the provision of money transmission services, via a branch network and ATMs, and a clearing system for the settlement of non-cash retail payments.
In the decades before the crash they diversified their income streams both in terms of geography – the UK, US and, in AIB’s case, Poland became overseas hunting grounds – and services – such as stockbroking, life assurance, corporate finance and wealth management.
Since the crash, the Irish banks have all scaled back their operations and returned to focusing primarily on providing lending and savings products in Ireland.
In 2005 and 2006, Lehman Brothers was the biggest issuer of securities against subprime mortgages, having acquired a number of specialist lenders in the preceding years. These were home loans given to people with impaired credit ratings.
Essentially, a lot of Americans were given loans they couldn’t afford and a large number of defaults began to emerge in 2007. This proved to be the beginning of the end for Lehman.
The collapse of Lehman in 2008 had a major ripple effect on the financial sector globally.
“Inter-bank lending” involves banks extending loans to one another. Most of these are for maturities of one week or less, often overnight, and they provide much needed liquidity – or cash flow – for institutions.
After the Lehman collapse, banks became wary of lending to each another. The absence of this liquidity forced governments in many countries, including Ireland, to step in and support their banks.