Post on 03-Mar-2018
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Why Are FinancialWhy Are Financial
IntermediariesIntermediaries
Special?Special?
Chapter 1
2008 The McGraw-Hill Companies, Inc., All Rights Resere!.McGraw-Hill/Irwin
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1-2Why Are FinancialIntermediaries Special?
Objectives: Develop the tools needed to measure and
manage the risks of FIs.
Explain the special role of FIs in the financial
system and the functions they provide. Explain hy the various FIs receive special
regulatory attention.
Discuss hat makes some FIs more special
than others.
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Without FIs
Corporations
(net borrowers)
Households
(net savers)
Cash
Euity ! "ebt
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FIs Specialness
!ithout FIs: "o level of fund flos. Information costs:
Economies of scale reduce costs for FIs to screen
and monitor borroers
"ess li#uidity $ubstantial price risk
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With FIs
Cash
Households Corporations
Euity ! "ebt
FI
(#ro$ers)
FI
(Asset
%rans&ormers)"eposits'Insurance
olicies
Cash
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Functions of FIs
%rokerage function&cting as an agent for investors:
e.g. 'errill "ynch( )harles $chab
*educe costs through economies of scale
Encourages higher rate of savings&sset transformer:
+urchase primary securities by selling financial
claims to households
, -hese secondary securities often more marketable, -ransformation of financial risk
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Role of FIs in Cost Reduction
Information costs: Investors exposed to &gency )osts
*ole of FI as Delegated 'onitor Diamond( /0123
, $horter term debt contracts easier to monitor than bonds
, FI likely to have informational advantage
FI as information producer
, 'onitoring poer and control
, &cting as delegated monitor( FIs reduce information
asymmetry beteen borroers and lenders
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Specialness of FIs
"i#uidity and +rice *isk $econdary claims issued by FIs have less price
risk
FIs have advantage in diversifying risks
*educed transaction 4 information costs economies of scale
%id5ask spreads narroer for assets bought andsold in large #uantities.
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Other Special Services
'aturity intermediation
-ransmission of monetary policy. )redit allocation &reas of special need such as
home mortgages3.
Intergenerational transfers or timeintermediation.
+ayment services Fed!ire and )6I+$3.
Denomination intermediation.
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Specialness and Regulation
FIs receive special regulatory attention.
*easons:
$pecial services provided by FIs in general.
Institution5specific functions such as money
supply transmission banks3( credit allocationthrifts( farm banks3( payment services
banks(thrifts3( etc.
7egative externalities arise if these services are
not provided.
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Regulation of FIs
Important features of regulatory policy: +rotect ultimate sources and users of savings.
Including prevention of unfair practices such as
redlining and other discriminatory actions.
+rimary role:Ensure soundness of the system as a hole.
*egulation is not costless
7et regulatory burden.
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Regulation
$afety and soundness regulation: *egulations to increase diversification
7o more than /8 percent of e#uity to single borroer
'inimum capital re#uirements
9uaranty funds: Deposit insurance fund DIF3:
$ecurities Investors +rotection Fund $I+)3
'onitoring and surveillance. FDI) monitors and regulates DIF participants.
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Gloal Issues
Increased competition from foreign FIs at
home and abroad'ergers involving orlds largest banks
'ergers blending together previously
separate financial services sectors
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Worlds !argest "an#s $%"illions&
%ank &ssets
%arclays %ank ;erland3 /(=?@.?
'itsubishi ;FA Aapan3 /(=81.=
6$%) 6oldings ;