lec 1 FINS3630

Chapter 1
Why are Financial Institutions
Special?

1

Overview
• This chapter explores why financial intermediaries are different from commercial firms.
• We discuss how financial intermediaries provide a special set of service to households and firms.
• We examine how this specialness requires a tighter regulation of financial intermediaries compared to other firms. 2

The world’s top 50 banks as of March 2009

http://www.guardian.co.uk/news/datablog/2009/mar/25/banking-g20
GFC and FIs

3

GFC and Bailouts

http://www.globalissues.org/article/768/global-financial-crisis#Thescaleofthecrisistrillionsintaxpayerbailouts
GFC and FIs

4

Bailout Programs
• United States
– Emergency Economic Stabilization Act and Troubled Asset
Relief Program
– Big institutions bailed: Bear Stearns (sold to JP Morgan Chase),
Merrill Lynch (sold to Bank of America), Fannie Mae and
Freddie Mac, American International Group, Washington
Mutual (sold to JP Morgan Chase), Citigroup

• United Kingdom
– 2008 United Kingdom bank rescue package
– Big institutions bailed: Lloyds and Royal Bank of Scotland

GFC and FIs

5

Financial Intermediaries’ Specialness
FI
Households

Cash

(Brokers)

FI

Corporations

Equity & Debt

(Asset
Transformers)
Deposits/Insurance
Policies/Units of
Trusts

Cash

FI Specialness

6

Flow of Capitals without FIs
• Households might find direct investments in corporate securities unattractive because of :
– Information/Monitoring costs,
– Liquidity costs,
– Price risk.

• As a result
– The flow of funds is likely to be low.
– Little or no monitoring would occur.
– Risk of investments would increase.

• Without financial intermediaries:
– Excess savings could only be held as cash or invested in corporate securities. FI Specialness

7

Financial Intermediaries’ Functions
• Brokerage function
– Acting as an agent for investors:
– Reduce costs through economies of scale