Financial intermediaries exist because of transaction costs, information asymmetries, and the need for risk diversification. They help reduce transaction costs for smaller actors, pool funds to diversify risk, and have expertise in gathering credit information. However, information asymmetries like adverse selection and moral hazard remain issues. Over time, deregulation and technology have transformed the financial system, with money market funds, commercial paper, and institutional investors like pension funds growing in importance and traditional banks facing more competition and taking on greater risks.
The principle of intermediation.ppt copySowie Althea
Financial intermediation refers to borrowing by economic deficit units from financial institutions in preference to borrowing directly from economic surplus units.
First of two research papers on issues involving the current economic downturn that I wrote during my senior year at NYU in collaboration with NYU professor, (both are pending professional publication).
Financial Market Failure and Regulation of the Financial Systemtutor2u
This is a study presentation on different causes of financial market failure and also policies introduced designed better to regulate the activities of the financial sector.
NYU Economics Research Paper (Independent Study) - Fall 2010jsmar16
First of two research papers on issues involving the current economic downturn that I wrote during my senior year at NYU in collaboration with NYU professor, (both are pending professional publication).
The principle of intermediation.ppt copySowie Althea
Financial intermediation refers to borrowing by economic deficit units from financial institutions in preference to borrowing directly from economic surplus units.
First of two research papers on issues involving the current economic downturn that I wrote during my senior year at NYU in collaboration with NYU professor, (both are pending professional publication).
Financial Market Failure and Regulation of the Financial Systemtutor2u
This is a study presentation on different causes of financial market failure and also policies introduced designed better to regulate the activities of the financial sector.
NYU Economics Research Paper (Independent Study) - Fall 2010jsmar16
First of two research papers on issues involving the current economic downturn that I wrote during my senior year at NYU in collaboration with NYU professor, (both are pending professional publication).
2013 05 17 mu mmia 17-05-2013 vt_eng+notesmummiaproject
Directive is to improve the right to information and to consultation of employees in Community-scale undertakings and Community-scale groups of undertakings.The arrangements for informing and consulting employees shall be defined and implemented in such a way as to ensure their effectiveness and to enable the undertaking or group of undertakings to take decisions effectively. Matters shall be considered to be transnational where they concern the Community-scale undertaking or Community-scale group of undertakings as a whole, or at least two undertakings or establishments of the undertaking or group situated in two different Member States.Direttva è intesa a migliorare il diritto all’informazione e alla consultazione dei lavoratori nelle imprese e nei gruppi di imprese di dimensioni comunitarie. Le modalità di informazione e consultazione dei lavoratori sono definite e attuate in modo da garantirne l’efficacia e consentire un processo decisionale efficace nell’impresa o nel gruppo di imprese. Sono considerate questioni transnazionali quelle riguardanti l’impresa di dimensioni comunitarie o il gruppo di imprese di dimensioni comunitarie nel loro complesso o almeno due imprese o stabilimenti dell’impresa o del gruppo ubicati in due Stati membri diversi. Directiva tiene por objeto la mejora del derecho de información y consulta a los trabajadores en las empresas y grupos de empresas de dimensión comunitaria.Las modalidades de información y consulta a los trabajadores se definirán y aplicarán de modo que se garantice su efectividad y se permita una toma de decisiones eficaz de la empresa o del grupo de empresas.Se considerarán transnacionales las cuestiones que afectan al conjunto de la empresa o grupo de empresas de dimensión comunitaria o al menos a dos empresas o establecimientos de la empresa o del grupo situados en dos Estados miembros diferentes. Das Ziel dieser Richtlinie ist die Stärkung des Rechts auf Unterrichtung und Anhörung der Arbeitnehmer in gemeinschaftsweit operierenden Unternehmen und Unternehmensgruppen.Die Modalitäten der Unterrichtung und Anhörung der Arbeitnehmer werden so festgelegt und angewandt, dass ihre Wirksamkeit gewährleistet ist und eine effiziente Beschlussfassung des Unternehmens oder der Unternehmensgruppe ermöglicht wird. directive a pour objectif d’améliorer le droit à l’information et à la consultation des travailleurs dans les entreprises de dimension communautaire et les groupes d’entreprises de dimension communautaire. Les modalités d’information et de consultation des travailleurs sont définies et mises en œuvre de manière à en assurer l’effet utile et à permettre une prise de décision efficace de l’entreprise ou du groupe d’entreprises. Sont considérées comme transnationales les questions qui concernent l’ensemble de l’entreprise de dimension communautaire ou du groupe d’entreprises de dimension communautaire, ou au moins deux entreprises situés dans deux États membres différents.
In 1984, in 1990 and in 2005 Congress passed laws exempting certain financial contracts from the standard provisions of the bankruptcy code. In each case, the effect of the law was to protect collateral securing the contract from those provisions of the bankruptcy code that allow a judge to review the claims of secured creditors and to protect the interests of other creditors whenever necessary.
The introduction of inequitable treatment into the bankruptcy code would be acceptable, if in fact the financial contract exemptions worked to protect the stability of the financial system. Recent experience indicates, however, that the special treatment granted to repurchase agreements and over the counter derivatives tends to reduce the stability of the financial system by encouraging collateralized interbank lending and discouraging careful analysis of the credit risk of counterparties. The bankruptcy exemptions also increase the risk that creditors will run on a financial firm and bankrupt it. Thus, the bankruptcy code has been rewritten to favor financial firms and this revision of the law has had a profoundly destabilizing effect on the financial system.
Social Investment Payoff:
Once upon a time in South
Africa, being HIV-positive
effectively meant you were
uninsurable. That was
until 10 years ago, when
one life insurer began to offer regular
medical tests alongside its policies.
In doing so, AllLife became the
world’s first company to sell whole-life
insurance cover to people on low
incomes with HIV. Its “continuous
underwriting” has since helped its clients
measure and manage their health
as well as helping it to price its products.
The Subprime Crisis & Implications for Microfinance (SVMN, 05/18/08)Dave McClure
Presentation on the US Subprime Crisis & Impact / Implications on Microfinance, by Katherine McKee, CGAP, to the Silicon Valley Microfinance Network (SVMN.net).
2. The Economics of Financial
Intermediation
In a world of perfect financial markets
there would be no need for financial
intermediaries (middlemen) in the
process of lending and/or borrowing
Costless transactions
Securities can be purchased in any
denomination
Perfect information about the quality of
financial instruments
3. Reasons for Financial
Intermediation
Transaction costs
Cost of bringing lender/borrower together
Reduced when financial intermediation is used
Relevant to smaller lenders/borrowers
Portfolio Diversification
Spread investments over larger number of securities and
reduce risk exposure
Option not available to small investors with limited funds
Mutual Funds —pooling of funds from many investors and
purchase a portfolio of many different securities
4. Reasons for Financial
Intermediation
Gathering of Information
Intermediaries are efficient at obtaining
information, evaluating credit risks, and are
specialists in production of information
Asymmetric Information
Adverse Selection
Moral Hazard
5. Asymmetric Information
Buyers/sellers not equally informed about
product
Can be difficult to determine credit worthiness,
mainly for consumers and small businesses
Borrower knows more than lender about
borrower’s future performance
Borrowers may understate risk
Asymmetric information is much less of a
problem for large businesses—more publicly
available information
6. Adverse Selection
Related to information about a business before a
bank makes a loan
Small businesses tend to represent themselves as
high quality
Banks know some are good and some are
bad, how to decide
Charge too high an interest, good credit companies look
elsewhere—leaves just bad credit risk companies
Charge too low interest, have more losses to bad companies
than profits on good companies
Market failure—Banker may decide not to lend money to
any small businesses
7. Moral Hazard
Occurs after the loan is made
Taking risks works to owners
advantage, prompting owners to make
riskier decisions than normal
Owner may “hit the jackpot”, however,
bank is not better off
From owner’s perspective, a moderate loss
is same as huge loss—limited liability
8. The Evolution of Financial
Intermediaries in the US
The institutions are very dynamic and
have changed significantly over the
years
The relative importance of different types of
institutions and has changed from 1952 to
2002
Winners—Pension funds and mutual fund
Losers—Depository institutions (except credit
unions) and life insurance companies
9. The Evolution of Financial
Intermediaries in the U.S.
Changes in relative importance caused by
Changes in regulations
Key financial and technological innovations
10. 1950s and Early 1960s
Stable interest rates
Fed imposed ceilings on deposit rates
Little competition for short-term funds from
small savers
Many present day competitors had not
been developed
Therefore, large supply of cheap
money
11. Mid 1960s
Growing economy meant increased demand
for loans
Percentages of bank loans to total assets
jumped from 45% in 1960 to nearly 60% in
1980
Challenge for banks was to find enough
deposits to satisfy loan demand
Interest rates became increasingly unstable
However, depository institutions still fell under
protection of Regulation Q
12. Regulation Q
Glass-Steagall Banking Act of 1933.
Prohibited the payment of interest on
demand deposits.
Ceiling on the maximum rate
commercial banks can pay on time
deposits.
Intent was to promote stability by
removing competition.
13. Consequences of Regulation
Q
Rising short-term interest rates meant depository
institutions could not match rates earned in money
market instruments such as T-bills and commercial
paper
Financial disintermediation —Wealthy investors
and corporations took money from depository
institutions and placed in money market instruments
However, option was not opened to small investor—
money market instruments were not sold in small
denominations
14. Bank Reaction to Regulation
Q
In 1961 banks were permitted to offer
negotiable certificates of deposit (CDs)
in denominations of $100,000 not
subject to Regulation Q
In mid-1960s short-term rates became
more volatile and wealthy investors
switched from savings accounts to large
CD’s
15. Money Market Mutual Fund
In 1971 Money Market mutual Funds were
developed and were a main cause in the
repeal of Regulation Q
Small investors pooled their funds to buy a
diversified portfolio of money market instruments
Some mutual funds offered limited checking
withdrawals
Small investors now had access to money market
interest rates in excess permitted by Regulation Q
16. The Savings and Loan (S&L) Crisis
As interest rates rose in late 1970s,
small investors moved funds out of
banks and thrifts
Beginning of disaster for S&Ls since
they were dependent on small savers
for their funds
17. The S&L Crisis
Depository Institutions Deregulation and
Monetary Control Act of 1980 and the
Garn-St. Germain Depository
Institutions Act of 1982
Dismantled Regulation Q
Permitted S&Ls (as well as other
depository institutions) to compete for
funds as money market rates soared
18. Change in the Financial
Makeup of S&Ls
Most of their assets (fixed-rate residential
mortgages, 30 year) yielded very low returns
Interest paid on short-term money (competing
with mutual funds) was generally double the
rate of return on mortgages
Market value of mortgages held by S&Ls fell
as interest rates rose making the value of
assets less than value of liabilities
19. The S&L Crisis
Since financial statements are based on historical costs, extent
of asset value loss was not recognized unless mortgage was
sold
Under the Garn-ST. Germain Act, S&Ls were permitted to invest
in higher yielding areas in which they had little expertise
(specifically junk bonds and oil loans)
Investors were not concerned because their deposits were
insured by Federal Savings and Loan Insurance Corporation
(FSLIC)
Result was an approximate $150 billion bail-out—paid for by
taxpayers
20. The Rise of Commercial
Paper
Financial disintermediation created
situation where corporations issued
large amounts of commercial paper
(short-term bonds) to investors moving
funds away from banks
This growth paralleled the growth in the
money market mutual funds
21. The Rise of Commercial
Paper
Banks lost their largest and highest
quality borrowers to commercial paper
market
To compensate for this loss of quality
loans, banks started making loans to
less creditworthy customers and lesser
developed countries (LDC’s)
As a result, bank loan portfolios became
riskier in the end of 1980s
22. The Evolution of Financial
Intermediaries
The increase in commercial paper was aided
by technological innovations
Computers and communication technology
permitted transactions at very low costs
Complicated modeling permitted financial
institutions to more accurately evaluate borrowers
—addressed the asymmetric problem
Permitted banks to more effectively monitor
inventory and accounts receivable used as
collateral for loans
23. The Institutionalization of
Financial Markets
Institutionalization—more and more funds
now flow indirectly into financial markets
through financial intermediaries rather than
directly from savers
These “institutional investors” have become
more important in financial markets relative to
individual investors
Easier for companies to distribute newly
issued securities via their investment bankers
24. Reason for Growth of
Institutionalization
Growth of pension funds and mutual funds
Tax laws encourage additional pensions and
benefits rather than increased wages
Legislation created a number of new
alternatives to the traditional employer-
sponsored defined benefits plan, primarily the
defined contribution plan
IRAs
403(b) and 401(k) plans
Growth of mutual funds resulting from the
alternative pension plans—Mutual fund families
25. The Transformation of
Traditional Banking
During 1970s & 80s banks extended
loans to riskier borrowers
Especially vulnerable to international
debt crisis during 1980s
Increased competition from other
financial institutions
Rise in the number of bank failures
26. The Transformation of
Traditional Banking
Although banks’ share of the market has
declined, bank assets continue to increase
New innovation activities of banks are not
reflected on balance sheet
Trading in interest rates and currency swaps
Selling credit derivatives
Issuing credit guarantees
27. The Transformation of
Traditional Banking
Banks still have a strong comparative
advantage in lending to individuals and small
businesses
Banks offer wide menu of services
Develop comprehensive relationships—easier to
monitor borrowers and address problems
In 1999 the Gramm-Leach-Bliley Act
repealed the Glass-Steagall Act of 1933
permitting the merging of banks with many
other types of financial institutions.
28. Financial Intermediaries: Assets,
Liabilities, and Management
Unlike a manufacturing company with real
assets, banks have only financial assets
Therefore, banks have financial claims on
both sides of the balance sheet
Credit Risks
Interest Rate Risks
29. Credit Risks
Banks tend to hold assets to maturity
and expect a certain cash flow
Do not want borrowers to default on
loans
Need to monitor borrowers continuously
Charge quality customers lower interest
rate on loans
Detect possible default problems
30. Interest Rate Risks
Banks are vulnerable to change in
interest rates
Want a positive spread between interest
earned on assets and cost of money
(liabilities)
Attempt to maintain an equal balance
between maturities of assets and liabilities
Adjustable rate on loans, mortgages,
etc. minimizes interest rate risks
31. Balance Sheets of Depository
Institutions
All have deposits on the right-hand side
of balance sheet
Investments in assets tend to be short
term in maturity
Do face credit risk because they invest
heavily in nontraded private loans
32. Balance Sheets of Non-
depository Financial
Intermediaries
Some experience credit risk associated with
nontraded financial claims
Asset maturities reflect the maturity of liabilities
Insurance and pension funds have long-term policies
and annuities—invest in long-term instruments
Consumer and commercial finance companies have
assets in short-term nontraded loans—raise funds by
issuing short-term debt