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INTERMEDIATION
Week 4
March 13 2014
CXHB7105
Financial Intermediation
Financial Institution:
Financial Intermediary:
Types of financial
institutions
2. Financial brokers
3. Investment institutions
Their main liabilities are deposits and main assets are loans.
Mutual funds: get money from small savers (individuals), who buy
shares in the fund; they in turn invest in variety of stocks, bonds,
etc.; allow individuals to pool their savings, diversify (avoid risk).
Finance companies: like banks, they use peoples savings to make
loans to businesses, but instead of holding deposits, they sell
bonds and commercial paper.
4. Contractual intermediaries
They hold and store individuals savings over long term PENSION
FUNDS and INSURANCE COMPANIES.
Financial Intermediation
Asset Transformation
Savers need
Asset transformation
Investors requirements
Asset transformer
Financial Intermediaries
Specialness
Asset transformer
Provision of liquidity
Provision of Liquidity
Transaction costs
Examples are
Time
Search costs
Credit risk assessment
documentation
Branch networks
Information networks e.g. ATM
Reduce cost of information collection
Economies of scale
Minimise costs
Transaction costs
ANY QUESTIONS?
Modern Theory of
Intermediation
Imperfect market
Asymmetric information
Asymmetric information
Adverse selection
Moral Hazard
Adverse selection
Adverse selection
Lemon Problem
Lemon problem
Produce information
Correctly sort borrowers
Signal their findings to other
Moral hazard
Moral Hazard
Moral hazard
Principal-Agent Problem
Another form of moral hazard
Managers = agents
AGENCY COSTS
Banking Regulation
Deposit insurance
Consequences of deposit
insurance
Adverse selection
Moral hazard
TOO-BIG-TO-FAIL Policy
Regulation to prevent
moral hazard
QUESTIONS?