Discuss the Major Outcomes of Financial Intermediation
Discuss the Major outcomes of Financial Intermediation (482 words) Financial Intermediation is referred to as an institution that acts as a ‘middleman’ per say between investors and firms raising funds (also known as financial institutions). These are firms such as chartered banks, insurance companies, investment dealers and pension funds.
Matthews and Thompson (2008) pp.35–36 show that financial intermediaries can be established by four qualities:
• Their main category of liabilities (deposits) are specified for a fixed sum which is not related to the performance of a portfolio
• The deposits are typically short-term and of a much shorter term than their assets
• A high proportion of their liabilities are chequeable (can be withdrawn on demand)
• Their liabilities and assets are largely not transferable. There are exceptions such as certificates of deposit and securitisation (see Chapter 6 of this subject guide). Financial Intermediaries have a huge effect on the economy. Without such institutions firms may be unable to fund their day-to-day business activities which will put a lot of pressure on these said activities and may reduce production as a whole. If this happens it will have negative effects on the economy and may lead to a recession (depending on how big the firm is). An example of this can be taken from the beginning of the recession we have recently experienced which began in roughly 2007 ‘Credit Crunch’. The financial intermediaries in this case banks, were accepting most mortgage applications without thoroughly checking that the consumer could re-pay the funds. This act led to a huge negative outcome. It is important to distinguish between banks as financial intermediaries (who accept deposits and make loans directly to borrowers) and non-bank financial intermediaries who lend via the purchase of securities. The latter category includes insurance companies, pension funds and investment trusts who purchase securities, thus providing capital
Matthews and Thompson (2008) pp.35–36 show that financial intermediaries can be established by four qualities:
• Their main category of liabilities (deposits) are specified for a fixed sum which is not related to the performance of a portfolio
• The deposits are typically short-term and of a much shorter term than their assets
• A high proportion of their liabilities are chequeable (can be withdrawn on demand)
• Their liabilities and assets are largely not transferable. There are exceptions such as certificates of deposit and securitisation (see Chapter 6 of this subject guide). Financial Intermediaries have a huge effect on the economy. Without such institutions firms may be unable to fund their day-to-day business activities which will put a lot of pressure on these said activities and may reduce production as a whole. If this happens it will have negative effects on the economy and may lead to a recession (depending on how big the firm is). An example of this can be taken from the beginning of the recession we have recently experienced which began in roughly 2007 ‘Credit Crunch’. The financial intermediaries in this case banks, were accepting most mortgage applications without thoroughly checking that the consumer could re-pay the funds. This act led to a huge negative outcome. It is important to distinguish between banks as financial intermediaries (who accept deposits and make loans directly to borrowers) and non-bank financial intermediaries who lend via the purchase of securities. The latter category includes insurance companies, pension funds and investment trusts who purchase securities, thus providing capital
References: Financial Intermediation: NewYorkFed (Unknown) Hedge Funds, Financial Intermediation, and Systemic Ris, [Online] newyorkfed Available http://www.newyorkfed.org/research/epr/07v13n3/0712kamb.pdf Bhattacharya, S. and A.V. Thakor ‘Contemporary banking theory’, Journal of Financial Intermediation, 3(1) 1993, pp.2–50; Sections 1, 2, and 7 Diamond, D.W. ‘Financial intermediation as delegated monitoring: A simple example’, Federal Reserve Bank of Richmond Economic Quarterly, 82(3) 1996, pp.51–66 Saunders and Cornett (2006) Chapter 1, pp.2–10, 15–21 Matthews and Thompson (2008) Chapter 3