global finance explained

7/26/2019 Global Finance Explained

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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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1-3

Without FIs

Corporations

(net borrowers)

Households

(net savers)

Cash

Euity ! "ebt


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1-4

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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1-5

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 ;

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