A bank's markets business — sometimes called the investment bank or the CIB (Corporate and Investment Bank) — generates revenue through a range of activities that look quite different from retail or commercial banking. There are no net interest margins from deposit-taking in the traditional sense; instead, revenue comes from providing services to clients, taking and managing risk, and intermediating between buyers and sellers across a vast array of financial instruments. Understanding these revenue streams is essential for anyone working in a markets environment.
Bid-Offer Spread: The Core of Market Making
The most fundamental way a bank makes money in markets is through the bid-offer spread. When a market maker provides a two-way price — a bid (the price at which it will buy) and an offer (the price at which it will sell) — the spread between those two prices represents the gross revenue from facilitating that transaction. If a dealer quotes 99.95 / 100.05 on a bond, and a client buys at 100.05 and another sells at 99.95, the dealer has earned 10 cents of spread per unit of notional, all else being equal.
In practice, "all else being equal" rarely holds. The dealer is left with inventory risk between the two trades — if the market moves against the position accumulated between the buy and the sell, the spread income is eroded or eliminated. Market making is therefore fundamentally a business of risk management: the spread compensates the dealer for the cost of bearing inventory risk, and the skilled market maker manages that risk efficiently enough that the spread income exceeds the hedging and inventory costs.
Spreads vary dramatically by product. In EUR/USD spot FX, spreads can be fractions of a basis point; in liquid government bonds, a few basis points; in structured credit, illiquid corporate bonds, or exotic derivatives, spreads of tens of basis points or more are common. Spread compression — driven by electronification and competition — has reduced per-trade profitability in liquid products over the past two decades, pushing banks toward higher-margin, less-liquid segments.
Facilitation vs Proprietary Trading
Post-2008 regulation — specifically the Volcker Rule in the US — significantly curtailed banks' ability to take purely proprietary trading positions (bets on market direction using the bank's own capital with no client rationale). Most banks now frame their market risk-taking as "facilitation" — taking on risk as a natural consequence of serving client flow, and managing it back to flat over time. The distinction matters for regulatory purposes, but in practice, any market maker accumulates directional risk through client flow and must decide how aggressively to hedge it. A skilled trader earns money both from the spread and from managing the resulting inventory position intelligently.
Flow vs Structured Products
Flow products are standardised, frequently traded instruments where volume and efficiency drive profitability: vanilla interest rate swaps, FX forwards, on-the-run government bonds, equity futures. Margins are thin, but volume is high. Structured products are bespoke instruments designed around a specific client need — an autocall structured note, a barrier option, a CLO tranche. Structured products carry much higher margins precisely because they cannot be easily priced by the client against a market price, and the complexity of the solution justifies the additional compensation. Banks that build strong structuring capabilities can earn margin from their intellectual capital rather than just from bid-offer on flow.
Prime Brokerage Revenue
Prime brokerage (PB) is the suite of services provided to hedge fund clients: custody of assets, securities financing (lending the hedge fund's long positions to short sellers in return for a fee), leverage provision, trade execution, and capital introduction. PB revenue comes from several sources:
- Securities lending income: When the PB lends a client's securities (equities, bonds) to short sellers, it earns a fee. For hard-to-borrow stocks, this fee can be substantial.
- Financing spread: The PB provides leverage to the hedge fund by financing long positions — lending cash against the collateral of the securities — at a spread above the bank's funding cost.
- Execution commissions: When the hedge fund routes trades through the PB's execution desk, the PB earns commission or spread.
Prime brokerage is a capital-intensive business because the PB extends credit to hedge funds; under Basel III leverage and capital rules, this balance sheet usage must be charged against the business. The most profitable prime brokerage relationships are those where the hedge fund uses significant leverage and generates large securities lending income from short positions, and where the balance sheet usage is offset by the financing spread earned.
Research: Post-MiFID II Unbundling
Before MiFID II (effective January 2018), banks charged for research implicitly through execution commissions — a client that used the bank's execution services effectively received research as part of the package. MiFID II required research to be priced and charged for separately ("unbundled") from execution. This had a significant impact on the economics of sell-side research: banks were forced to price their research explicitly, leading to substantial cuts in research headcount across the industry as clients chose to pay only for the research they valued most.
Research remains an important driver of client relationships and order flow, even where it is no longer bundled into commissions. A bank with well-regarded research in a sector attracts client calls and, ultimately, execution business.
Financing Income: Repo and Securities Lending
Beyond prime brokerage, banks earn significant income from financing activities — providing cash against collateral through repo, or lending securities to counterparties who need to borrow them (typically to cover short positions). Repo income arises from the spread between the rate at which the bank finances itself and the rate at which it on-lends to clients. In periods of elevated collateral scarcity — when high-quality liquid assets are in short supply — repo spreads can widen significantly, boosting financing income.
Agency vs Principal Model
In the agency model, the bank acts purely as an intermediary, matching buyers and sellers without taking on risk itself, and earns a commission for doing so. In the principal model, the bank acts as counterparty — buying from one client and selling to another, taking risk in between — and earns the bid-offer spread. Most banks operate on a principal basis in OTC derivatives and bonds, and on an agency basis in listed equities and exchange-traded derivatives (though they will also cross client flow in listed markets where permitted). The principal model offers higher revenue per trade but requires balance sheet and risk capital; the agency model is capital-light but generates lower margins.