Topic 6 How Banks Work.pdf - HOW BANKS WORK AND FINANCIAL CRISIS Topic 6 Chapter 8 The Role of Banks ◼ A bank is a financial intermediary that accepts

Topic 6 How Banks Work.pdf - HOW BANKS WORK AND FINANCIAL...

This preview shows page 1 - 6 out of 20 pages.

HOW BANKS WORK AND FINANCIAL CRISIS Topic 6 Chapter 8
Image of page 1

Subscribe to view the full document.

The Role of Banks A bank is a financial intermediary that accepts deposits from savers and makes loans to borrowers. Many types of intermediaries perform both these services: commercial banks, thrift institutions (savings banks and savings- and-loan associations), and credit unions. Banks are efficient in combining small deposits from savers to make larger loans to borrowers. Specifically, they provide liquidity for people and for businesses, both borrowers and lenders. Banks are adept at: a) pooling funds b) gathering information about borrowers 2
Image of page 2
Asymmetric Information Banks gather information about potential borrowers to determine their ability to repay loans. Both borrowers and lenders want to paint the best possible picture when presenting themselves to banks. Asymmetric information is a situation where one party to a transaction knows more, has more information, than the other. Asymmetric information causes two problems: Adverse selection Moral hazard 3
Image of page 3

Subscribe to view the full document.

Adverse Selection Adverse Selection occurs when people or firms that are worse than average risks are more likely to enter a contract that is offered to everyone; in banking it means that bad borrowers are more likely to seek a loan than good borrowers. Example: the market for “lemons” The market for used cars contains cars of lower than average quality. The least desirable (highest risk) borrowers are the most likely to accept loans at high interest rates. 4
Image of page 4
Moral Hazard In a situation of moral hazard , the existence of a contract changes the behavior of a party to the contract, doing harm to the other party.
Image of page 5

Subscribe to view the full document.

Image of page 6
  • Fall '19

What students are saying

  • Left Quote Icon

    As a current student on this bumpy collegiate pathway, I stumbled upon Course Hero, where I can find study resources for nearly all my courses, get online help from tutors 24/7, and even share my old projects, papers, and lecture notes with other students.

    Student Picture

    Kiran Temple University Fox School of Business ‘17, Course Hero Intern

  • Left Quote Icon

    I cannot even describe how much Course Hero helped me this summer. It’s truly become something I can always rely on and help me. In the end, I was not only able to survive summer classes, but I was able to thrive thanks to Course Hero.

    Student Picture

    Dana University of Pennsylvania ‘17, Course Hero Intern

  • Left Quote Icon

    The ability to access any university’s resources through Course Hero proved invaluable in my case. I was behind on Tulane coursework and actually used UCLA’s materials to help me move forward and get everything together on time.

    Student Picture

    Jill Tulane University ‘16, Course Hero Intern

Ask Expert Tutors You can ask 0 bonus questions You can ask 0 questions (0 expire soon) You can ask 0 questions (will expire )
Answers in as fast as 15 minutes