Financial intermediaries


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Financial intermediaries

  1. 1. An institutions that connect borrowers and lenders by accepting funds from lenders and loaning funds to borrowers. INCLUDE:  BANKS  INSURANCE COMPANIES  CREDIT UNIONS  MUTUAL FUNDS 1. All FIs are exposed to some degree of liability withdrawal or liquidity risk 2. Most FIs are exposed to some type of underwriting risk 3. All FIs are exposed to operating cost risks
  2. 2. In such a world, savings would flow from households to corporations; in return, financial claims (equity and debt securities) would flow from corporations to household savers.
  3. 3. Is serve as conduits between users and savers of funds by providing a brokerage function and by engaging in an asset transformation function.
  4. 4. Brokerage Function can benefit both savers and users of funds and can vary according to the firm. FIs may provide only transaction services, such as discount brokerages, or they also may offer advisory services which help reduce information costs, such as full- line firms. Asset transformation function is accomplished by issuing their own securities, such as deposits and insurance policies that are more attractive to household savers, and using the proceeds to purchase the primary securities of corporations.
  5. 5. The concept that the cost reduction in trading and other transaction services results from increased efficiency when FIs perform these services. An FI issues financial claims that are more attractive to household savers than the claims directly issued by corporations.
  6. 6. Securities issued by corporations and backed by the real assets of those corporations. Securities issued by FIs and backed by primary securities.
  7. 7. The aggregation of funds in an FI provides greater incentive to collect information about customers (such as corporations) and to monitor their actions. The relatively large size of the FI allows this collection of information to be accomplished at a lower average cost (so-called economies of scale) than would be the case for individuals.
  8. 8. Costs relating to the risk that the owners and managers of firms that receive savers’ funds will take actions with those funds contrary to the best interests of the savers. An economic agent appointed to act on behalf of smaller agents in collecting information and/or investing funds on their behalf.
  9. 9. By putting excess funds into financial institutions, individual investors give to the FIs the responsibility of deciding who should receive the money and of ensuring that the money is utilized properly by the borrower. The FI can utilize this information to create new products, such as commercial loans, that continually update the information pool. This more frequent monitoring process sends important informational signals to other participants in the market, a process that reduces information imperfection and asymmetry between the ultimate providers and users of funds in the economy.
  10. 10. FIs provide financial secondary claims to household savers with superior liquidity attributes and with lower price risk.
  11. 11. EXAMPLE:  Banks and Thrifts issue transaction account deposit contracts with a fixed principal value (and often a guaranteed interest rate) that can be withdrawn immediately on demand by household savers.  Money market mutual funds issue shares to household savers that allow those savers to enjoy almost fixed principal contracts while often earning interest rates higher than those on bank deposits.  Life insurance companies allow policyholders to borrow against their policies held with the company at very short notice.
  12. 12. Reducing risk by holding a number of securities in a portfolio. The less diversified the FI, the higher the probability that it will default on its liability obligations and the more risky and illiquid its claim. In reality, the majority of financial institution failures involve small FIs that are relatively undiversified product wise and geographically.