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
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