Financial Intermediaries

10 Key excerpts on "Financial Intermediaries"

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  CFIN

  • Scott Besley, Eugene Brigham, Scott Besley(Authors)
  • 2021(Publication Date)
  • Cengage Learning EMEA

    (Publisher)

  When intermediaries ac- cept funds (generally called deposits) from savers, they issue securities with such names as savings accounts, money market funds, and pension plans, that represent claims, or liabilities, against the institutions. The funds received by intermediaries are, in turn, lent to businesses and individuals via debt instruments created by these in- stitutions, which include automobile loans, mortgages, commercial loans, and similar types of debt. The process by which Financial Intermediaries transform funds pro- vided by savers into funds used by borrowers is called financial intermediation. The lower panel of Figure 3.1 illustrates the financial intermediation process. The ar- rows at the top portion of the boxes (pointing to the right) indicate the changes in the balance sheets of sav- ers, borrowers, and intermediaries that result from the intermediation process. The arrows at the bottom por- tion of each box (pointing to the left) show the flow of funds from savers to borrowers through intermediaries. Without Financial Intermediaries, savers would have to provide funds directly to borrowers, which would be a difficult task for those who do not possess such expertise; such loans as mortgages and automobile financing would be much more costly, so the financial markets would be much less efficient economically. Clearly, the presence of intermediaries improves economic well-being. In fact, Financial Intermediaries were created to reduce the inef- ficiencies that would otherwise exist if users of funds could get loans only by borrowing directly from individual savers. Improving economic well-being is only one of the benefits associated with intermediaries. Following are other benefits: 1. Reduced costs—Without intermediaries, the net cost of borrowing would be greater, and the net return earned by savers would be less, because individuals with funds to lend would have to seek out appropri- ate borrowers themselves, and vice versa.

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  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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  Basic Finance

  An Introduction to Financial Institutions, Investments, and Management

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

    (Publisher)

  The funds are initially lent to the intermediary, and the intermediary subsequently lends the funds to the ultimate users. To obtain the funds, the finan-cial intermediaries create claims on themselves . This creation of claims is an impor-tant distinction. An investment banker facilitates an initial sale; securities brokers and secondary markets facilitate subsequent sales. Investment bankers, brokers, and securities exchanges do not create claims on themselves. They are not financial inter-mediaries but rather function as middlemen who facilitate the buying and selling of new and existing securities. When a saver deposits funds in a financial intermediary such as a bank, that indi-vidual receives a claim on the bank (the account) and not on the firm (or individual or government) to whom the bank lends the funds. If the saver had lent the funds directly to the ultimate users and they failed, the saver would sustain a loss. This loss may not occur if the saver lends the money to a financial intermediary. If a financial intermediary makes a bad loan, the saver does not sustain the loss unless the finan-cial intermediary fails. Even then the saver may not sustain a loss if the deposits are insured. The combination of the intermediary’s diversified portfolio of loans and the insurance of deposits has made Financial Intermediaries a primary haven for the sav-ings of many risk-averse investors. (Diversification is an important topic in finance and is covered at length in Chapter 8 on the analysis of risk.) To tap these savings, a variety of intermediaries has evolved. These include com-mercial banks, thrift institutions (savings and loan associations, mutual savings banks, and credit unions), and life insurance companies. Many savers are probably not aware of the differences among these Financial Intermediaries. They offer similar services and pay virtually the same rate of interest on deposits.

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  Demystifying Global Macroeconomics

  • John E. Marthinsen(Author)
  • 2020(Publication Date)
  • De Gruyter

    (Publisher)

  Chapter 7 Financial Intermediation For most businesses, having sufficient access to lines of credit at banks or other financial institutions is as essential to their health and survival as adequate access to water is for families. In the course of providing liquidity to businesses and individuals, Financial Intermediaries do more than just channel funds from lenders and savers to borrowers. They also act as independent money creators for the nation as a whole. The speed at which a nation ’ s money supply changes is important because it affects the rate and sustainability of real economic growth and development, as well as inflation. A central bank ’ s job is to ensure that the money supply is not growing so slowly that it causes a recession or too rapidly that it causes unwanted inflation. Central banks control Financial Intermediaries by regulating and supervis-ing both the structure and size of their balance sheets. This chapter discusses the bank assets and liabilities that are important to the money creation process, as well as the vital role that a nation ’ s check-clearing process plays in our financial system. The Rest of the Story section of this chapter discusses how companies use check clearing in their cash management systems, the process of international check clearing, financial dis intermediation, and ten major causes of bank failures. The Basics Financial Intermediaries What role do Financial Intermediaries play in an economy? Why do people place funds in Financial Intermediaries, such as banks and thrift institutions 1 when they could lend directly to borrowers and earn higher returns? Direct Versus Indirect Financing To frame our discussion, let ’ s divide the economy into two segments, with ulti-mate lenders and savers (lenders/savers) on one side and ultimate borrowers on the other side (see Figure 7.1).

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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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  The Economics of Banking

  • Kent Matthews, John Thompson(Authors)
  • 2014(Publication Date)
  • Wiley

    (Publisher)

  CHAPTER 3 Banks and Financial Intermediation MINI-CONTENTS 3.1 INTRODUCTION 3.2 DIFFERENT REQUIREMENTS OF BORROWERS AND LENDERS 3.3 TRANSACTION COSTS 3.4 LIQUIDITY INSURANCE 3.5 ASYMMETRY OF INFORMATION 3.6 OPERATION OF THE PAYMENTS MECHANISM 3.7 DIRECT BORROWING FROM THE CAPITAL MARKET 3.8 CONCLUSION 3.9 SUMMARY 3.1 INTRODUCTION In this chapter we examine the role of financial intermediation in general and banks in particular. Financial intermediation refers to borrowing by deficit units from financial institutions rather than directly from the surplus units themselves. Hence, financial interme- diation is a process that involves surplus units depositing funds with financial institutions that in turn lend to deficit units. This is illustrated in Figure 3.1. In fact, the major external source of finance for individuals and firms comes from Financial Intermediaries – Mayer (1990) reports that over 50% of external funds to firms in the USA, Japan, the UK, Germany and France were provided by Financial Intermediaries. Financial Intermediaries 1 can be distinguished by four criteria: 1. Their liabilities, i.e. deposits, are specified for a fixed sum that is not related to the performance of their portfolio. 1 They are now described as Monetary Financial Institutions in statistics produced by the Bank of England. 2. Their deposits are of a short-term nature and always of a much shorter term than their assets. 3. A high proportion of their liabilities are chequeable. 4. Neither their liabilities nor their assets are in the main transferable. This aspect must be qualified by the existence of certificates of deposit (see Chapter 4 for a description of these assets) and securitization (see Chapter 9 for a full discussion of securitization). At the outset it is useful to make the distinction between Financial Intermediaries who accept deposits and make loans directly to borrowers and those who lend via the purchase of securities.

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  Handbook of Monetary Economics 3A

  • (Author)
  • 2010(Publication Date)
  • North Holland

    (Publisher)

  In conventional models of monetary economics commonly used in central banks, the banking sector has not played a prominent role. The primary friction in such models is the price stickiness of goods and services. Financial Intermediaries do not play a role, except as a passive player that the central bank uses as a channel to implement monetary policy.

  However, Financial Intermediaries have been at the center of the global financial crisis that erupted in 2007. They have borne a large share of the credit losses from securitized sub-prime mortgages, even though securitization was intended to parcel out and disperse credit risk to investors who were better able to absorb losses. Credit losses and the associated financial distress have figured prominently in the commentary on the downturn in real economic activity that followed. These recent events suggest that Financial Intermediaries may be worthy of separate study to ascertain their role in economic fluctuations.

  The purpose of this chapter is to reconsider the role of Financial Intermediaries in monetary economics. In addressing the issue of financial factors in macroeconomics, we join a spate of recent research that has attempted to incorporate a financial sector in a New Keynesian DSGE model. Curdia and Woodford (2009) and Gertler and Karadi (2009) are recent examples. However, rather than phrasing the question of how financial “frictions” affect the real economy, we focus on the financial intermediary sector. We explore the hypothesis that the financial intermediary sector, far from being passive, is instead the engine that drives the boom-bust cycle. To explore this hypothesis, we propose a framework for study to address the following pair of questions. What are the channels through which Financial Intermediaries exert an influence on the real economy (if at all)? What are the implications for monetary policy?

  Banks and other Financial Intermediaries borrow in order to lend. Since the loans offered by banks tend to be of longer maturity than the liabilities that fund those loans, the term spread is indicative of the marginal profitability of an extra dollar of loans on intermediaries’ balance sheets. The net interest margin (NIM) of the bank is the difference between the total interest income on the asset side of its balance sheet and the interest expense on the liabilities side of its balance sheet. Whereas the term spread indicates the profitability of the marginal loan that is added to the balance sheet, the NIM is an average concept that applies to the stock of all loans and liabilities on the balance sheet.

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  Handbook of Monetary Economics vols 3A+3B Set

  • Benjamin M. Friedman, Michael Woodford(Authors)
  • 2010(Publication Date)
  • North Holland

    (Publisher)

  In conventional models of monetary economics commonly used in central banks, the banking sector has not played a prominent role. The primary friction in such models is the price stickiness of goods and services. Financial Intermediaries do not play a role, except as a passive player that the central bank uses as a channel to implement monetary policy.

  However, Financial Intermediaries have been at the center of the global financial crisis that erupted in 2007. They have borne a large share of the credit losses from securitized subprime mortgages, even though securitization was intended to parcel out and disperse credit risk to investors who were better able to absorb losses. Credit losses and the associated financial distress have figured prominently in the commentary on the downturn in real economic activity that followed. These recent events suggest that Financial Intermediaries may be worthy of separate study to ascertain their role in economic fluctuations.

  The purpose of this chapter is to reconsider the role of Financial Intermediaries in monetary economics. In addressing the issue of financial factors in macroeconomics, we join a spate of recent research that has attempted to incorporate a financial sector in a New Keynesian DSGE model. Curdia and Woodford (2009) and Gertler and Karadi (2009) are recent examples. However, rather than phrasing the question of how financial “frictions” affect the real economy, we focus on the financial intermediary sector. We explore the hypothesis that the financial intermediary sector, far from being passive, is instead the engine that drives the boom-bust cycle. To explore this hypothesis, we propose a framework for study to address the following pair of questions. What are the channels through which Financial Intermediaries exert an influence on the real economy (if at all)? What are the implications for monetary policy?

  Banks and other Financial Intermediaries borrow in order to lend. Since the loans offered by banks tend to be of longer maturity than the liabilities that fund those loans, the term spread is indicative of the marginal profitability of an extra dollar of loans on intermediaries' balance sheets. The net interest margin (NIM) of the bank is the difference between the total interest income on the asset side of its balance sheet and the interest expense on the liabilities side of its balance sheet. Whereas the term spread indicates the profitability of the marginal loan that is added to the balance sheet, the NIM is an average concept that applies to the stock of all loans and liabilities on the balance sheet.

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  Financial Systems

  Principles and Organization

  • Edwin H. Neave(Author)
  • 2002(Publication Date)
  • Routledge

    (Publisher)

  This chapter examines strategic management in Financial Intermediaries. One of the most important of an intermediary’s strategic decisions is choosing its organisational structure. A second, equally important challenge is preparing the firm to respond to future changes—either in its markets or in the technology it might employ. The chapter first outlines the factors affecting profitability when intermediaries consider whether their organisational structure might better be that of a multiproduct or a specialised firm. Next, the chapter examines economic issues that arise in adapting to changing markets or to technological change. Third, the chapter outlines the basic economics of intermediary operations. Finally, the chapter develops a model explaining how balancing expected profitability against risk can be studied.

  15.2 ECONOMICS OF INTERMEDIATION

  Like any financial firm, intermediaries structure themselves to meet and if possible outperform the competition. Management tries to lead or at least keep abreast of market developments, and at the same time tries to operate as profitably as possible. Meeting these two challenges means that intermediaries adapt their business to changing opportunities. As one example, intermediaries still perform their traditional role of raising funds through deposits and repackaging the funds as loans, but they are increasingly also acting as agents for financings they do not retain on their own books.

  In performing their traditional roles, intermediaries gather savings deposited in small individual accounts and then lend out the funds in typically larger amounts— an activity sometimes called denomination intermediation. They employ maturity intermediation when they use their short term funds (i.e., funds deposited in chequing and savings accounts) to finance medium term loans. Intermediary operations also transform risk: the depositing client of an intermediary does not face the same default risk as she would if she lent funds directly to one of the intermediary’s clients. The depositor’s risk is related to the diversified risk of the intermediary’s asset portfolio rather than to the credit risk of the borrowing client. Risk is also transformed when portfolios of intermediary loans are securitised: the original loans are repackaged into a diversified portfolio which is then offered as collateral for securities purchased by institutional investors.

  Despite the advantages of diversification, the uninsured depositor can still face default risk: unsound lending practices can cause an intermediary to fail. Thus when deciding where to place their short term funds, large depositors are wise to take the intermediary default risk into account. On the other hand, small depositors do not face default risk in jurisdictions where their funds are protected by deposit insurance.1

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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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