Economic Functions of Financial Intermediaries

7 Key excerpts on "Economic Functions of Financial Intermediaries"

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  eBook - PDF

  Monetary Economics

  Theories, Evidence and Policy

  • David G. Pierce, Peter J. Tysome(Authors)
  • 2014(Publication Date)
  • Butterworth-Heinemann

    (Publisher)

  Financial intermediaries and the supply of money The purpose of this chapter is threefold. Firstly to outline the nature and functions of financial intermediaries in general. Secondly to examine the way in which the money supply is determined, and in so doing to pay particular attention to the banks as suppliers of money. Thirdly to consider the importance of the non-bank financial intermediaries (NBFIs), both for the total flow of credit and for the volume of bank deposits. The nature and functions of fínancial intermediaries Financial intermediaries are economic units whose primary function is 'to purchase primary securities from ultimate borrowers and to issue indirect debt for the portfolios of ultimate lenders' (Gurley and Shaw, 1960). Ultimate borrowers are individuals or institutions who wish to spend on real resources in excess of their income (sometimes called deficit spenders) and who intend to finance the additional expenditure by borrowing. Such borrowings may be for a variety of purposes and may be undertaken either by persons or by institutions. Individuals borrow, for example, in order to finance the purchase of consumer durables, and to finance the purchase of a house. Firms borrow to finance purchases of capital equipment, while governments borrow to finance a variety of capital expenditures. When such borrowings are made the borrower will usually have to provide some form of security and enter some form of contract to repay the sum borrowed, usually over some specified period of time. In effect they may be regarded as providing a claim upon themselves in return for the money borrowed. It is convenient to regard these claims, which we call primary securities, as being sold.

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  The Influence of Uncertainty in a Changing Financial Environment

  An Inquiry into the Root Causes of the Great Recession of 2007-2008

  • Ricardo A. Halperin(Author)
  • 2017(Publication Date)
  • Palgrave Macmillan

    (Publisher)

  THE THEORY OF FINANCIAL INTERMEDIATION Neoclassical economists were aware that the decisions to save and to invest were largely taken by different economic actors. They argued that finan- cial intermediaries (at that time this reference was almost synonymous with commercial banks) brought them together and posited that interest rates were the variable that enabled savings and investment to come into equilibrium. Later an alternative consideration became common in the financial lit- erature: different economic actors have different appetites for risk, and the role of financial intermediaries is to allocate these risks in an optimizing manner. The development of forward markets, and later of derivatives, serves to highlight this important role. Finally, a third consequence of financial intermediation needs to be highlighted. Financial intermediaries do not just shift risks within the R.A. HALPERIN 79 economy, they also create liquidity and rely on leverage for their profits, and in the process they create new risks. These three perspectives on financial intermediation are not mutually exclusive, each one illustrates one of the roles of the financial sector, but it is the third one, sometimes overlooked, which deserves special attention as we try to understand how the economy works and what drives economic fluctuations. When the role of financial intermediaries creating, or absorbing, liquid- ity is taken into account, it becomes clear that intermediaries do not play a neutral role as sometimes assumed. Indeed, the word “intermediary” becomes misleading, as by creating additional risks they affect the evolu- tion of the economy. In addition, while liquidity is obviously necessary for the smooth functioning of the economy, it is far from evident that the more liquidity the better. On the contrary, at some point the negative consequences of additional liquidity start to exceed its benefits.

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  Basic Finance

  An Introduction to Financial Institutions, Investments, and Management

  • Herbert Mayo, , , (Authors)
  • 2018(Publication Date)
  • Cengage Learning EMEA

    (Publisher)

  Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it. 12 I n Hamlet , Polonius gave Laertes the advice to “neither a borrower nor a lender be.” Participants in financial markets and financial intermediaries violate both parts of that advice. Financial intermediaries borrow from one group and lend to another, a process that channels resources into productive investments. Consider how firms would be constrained if they could not borrow funds to purchase plant and equipment or how individuals would be prevented from purchasing homes by borrowing funds through mortgage loans. This transfer of savings through financial intermediaries— from individuals with funds to firms, governments, and other individuals who need funds—is one crucial component of the financial system. Financial markets perform two exceedingly important functions. Like financial intermediaries, financial markets facilitate the transfer of funds from savers to firms, governments, and individuals who use the funds. Financial markets, however, also facilitate the transfer of existing securities from sellers to buyers. You and I are willing to make investments because we know these investments may be subsequently sold through the financial markets. This chapter sets the framework for the remaining chapters in this text. It begins with the roles of money and interest rates. This is followed by transfer of savings to in-vestments and the purpose of financial intermediaries through which these savings are channeled to the ultimate users of the funds. (The process of transferring funds through investment banking and the “secondary” markets in existing securities is covered in Chapters 3 and 4.) In terms of the amount of outstanding loans, commercial banks are the most important financial intermediary.

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  Financial Integration in the European Monetary Union

  • Sławomir Ireneusz Bukowski(Author)
  • 2019(Publication Date)
  • Routledge

    (Publisher)

  B. Scholtens and D. van Wensveen (2003, pp. 35–37) point to an essential characteristic of financial intermediation, namely creating added value for savers and investors comprised in financial instruments. This type of instrument cannot be created together or individually by savers and investors. This process of added value creation is intensified by competition between the existing financial institutions and those entering the market and introducing financial innovations. Financial institutions must continuously analyze the preferences of the financial market participants and translate these preferences into characteristics of new financial products. An important function of financial intermediation institutions is risk transformation. They create added value by creating financial instruments that absorb risk. In this way, the sector of financial intermediation institutions has evolved into the financial industry sector (see also Allen & Santomero, 1997, pp. 1461–1476; Merton & Bodie, 1995, pp. 1–27; Allen & Gale, 2001, pp. 127–149).

  As it was mentioned before, the relationship between the role and place in the market of financial intermediation institutions (banks, insurance societies, investment funds, etc.) and the market of financial instruments has changed. In the traditional system, direct customers of financial intermediaries – savings providers and borrowers – were households of lower income and assets and small and medium-size enterprises (SMEs).

  In the modern system formed as a result of the just-described phenomena related to knowledge-based economy, households and SMEs are customers of financial intermediation institutions that intermediate in investing resources obtained from them in the market of financial instruments (especially those listed in organized markets) and offering products based on exchange listed financial instruments. On the other hand, big companies benefit, to a large extent, from raising financial resources directly in organized capital markets (exchanges).

  It is a result of the just-described factors that financial intermediation institutions have become financial product providers creating added value. At the same time, such a state of affairs indicates the growing role of financial markets in economy and even the fact that they have become “the heart” of the financial system and market economy and the money and information “pump.”

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  Economic Development in the Middle East and North Africa

  Challenges and Prospects

  • Mohamed Sami Ben Ali(Author)
  • 2016(Publication Date)
  • Palgrave Macmillan

    (Publisher)

  M. S. Ben Ali, N. Samargandi, and K. Sohag 156 markets, and intermediary types. Financial systems, in ameliorating market frictions, naturally impact resource allocation (Merton and Bodie, 1995). For example, financial contracts that increase the con- fidence of investors being paid back by firms will probably influence the way people distribute their savings. Financial development occurs at the moment when financial market intermediaries ameliorate the effects of implementation, and transac- tions costs, doing better at providing the financial functions, as any one of these functions can affect savings and investment decisions and therefore economic growth. Due to the existence of many frictions and country differences over time, improvement has differing implica- tions for the allocation of resources and welfare. Evaluating firms, managers, and market conditions prior to deci- sion making has large costs. Individuals may face high information costs when trying to obtain the necessary investment knowledge required to make an educated decision, and so this keeps capital from flowing to the most profitable uses and firms (Bagehot, 1873). These costs could be reduced when financial intermediaries interfere in this process, improving by the same the allocation of resources (Boyd and Prescott, 1986). Without these intermediaries, the fixed costs associ- ated with evaluating all the necessary points investors have to evalu- ate would be associated with such a task and so, to undertake this costly process, financial intermediaries may be formed by groups of individuals. The production of information may be stimulated by stock mar- kets. The bigger and more liquid a market is, the greater the incen- tives to expend resources in obtaining such information on firms as it becomes easier to profit of said information (Holmstrom and Tirole, 1993).

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  Banking in China

  Second Edition

  • V. Cousin(Author)
  • 2011(Publication Date)
  • Palgrave Macmillan

    (Publisher)

  Financial intermediation is not only a function undertaken by banks. Capital and money markets, as well as venture capital for example, can also allocate funds to productive uses. Financial intermediation can also take some informal traits when family, friends or other unregistered entities, for example, support an enterprise financially (either with debt or capital). 6.2 Financial intermediation and financial infrastructure A number of researchers have found that there is a low level of financial intermediation in China. Genevieve Boyreau-Debray (2003: 18) finds an ‘inverse relationship between the rate of financial intermediation and the Table 6.1 Local currency loans and deposits in China (year-end, CNY billion) 2000 2002 2004 2005 2007 2008 2009 Total loans 9,937 13,129 17,736 19,469 26,169 30,339 42,562 Total deposits 12,38 17,092 24,053 28,717 38,937 46,620 61,201 Loan to deposit ratio (%) 80.3 76.8 73.7 67.8 67.2 65.1 69.5 Source: Based on data from www.pbc.gov.cn. Table 6.2 Loans by economic sector and their share of GDP (%) 2000 2005 2008 to GDP* to loan portfolio** to GDP to loan portfolio to GDP to loan portfolio Loans to agriculture 15.1 7.4 12.2 13.2 11.3 14.1 Loans to construction 5.6 2.5 5.5 3.4 5.7 2.9 Loans to industry 40.4 25.9 42.2 25.7 42.9 28.9 Loans to commerce 39 27.2 40.1 18.8 40.1 14.2 Other loans 37.0 38.8 39.9 * is the percentage that this economic sector contributes to GDP. ** is the percentage of short- term loans lent by financial institutions to this particular economic sector. Notes: The National Bureau of Statistics publishes the contribution to GDP for the primary, the secondary and the tertiary sector and for the construction industry. The ‘other loans’ category is as stated in the PBOC statistics. Sources: Data from www.pbc.gov.cn and www.stats.gov.cn.

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  Speculative Management

  Stock Market Power and Corporate Change

  • Dan Krier(Author)
  • 2012(Publication Date)
  • SUNY Press

    (Publisher)

  capitalism in recent times. The widely used term financial intermediaries, which designates institutions between corporations (as users of capital) and primary fi- nancial markets (as suppliers of capital), inspired the conception of so- cial intermediaries. Financial intermediaries include investment banks, commercial banks, and the institutions that support them. Financial in- termediaries supply corporations with capital and investors with invest- ments. Corporations relate to primary financial markets through these institutions to obtain loans or float new equity or debenture securities. Through bank deposits and security purchases, investors supply funds to corporations through these institutions. The process of financial inter- mediation has received extensive attention in academic writing, and in- deed the entire field of financial economics was traditionally aimed at understanding primary markets and the issuance of securities. But this literature is of limited use for this study because secondary markets have supplanted primary security markets as the most consequential environ- ment of corporations. This study seeks to develop a conceptualization of institutional ties between corporations and the increasingly critical sec- ondary market for already-issued corporate securities. Chapter 2 described the rise of transactional finance in the late twentieth century that made secondary security markets a permanent 92 SPECULATIVE MANAGEMENT environment toward which corporations and investors continuously ori- ent their actions. Although primary markets and the financial interme- diaries that link firms to them are fleetingly critical to corporate management, secondary markets are a chronic aspect of the daily com- mand and control structure of U.S. corporations and were of prime im- portance for explaining corporate restructuring.

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