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Unformatted text preview: EC372 Bond and Derivatives Markets Topic #9: Financial Intermediation, I: Fundamentals R. E. Bailey Department of Economics University of Essex Outline Contents 1 Functions of Financial Intermediaries 1 2 Bank risks: a Balance Sheet Approach 2 2.1 Regulation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3 3 Securitisation 4 4 A Screening Model of Bank Lending 6 Reading: Lecture notes (available in the CMR) 1 Functions of Financial Intermediaries Functions of Financial Intermediaries 1. Payments system a mechanism for the transfer of cash, via bank deposits. 2. Risk sharing dividing up the risks associated with large assets that would otherwise be indi- visible. 3. Risk pooling by holding a portfolio of assets with imperfectly correlated returns, the inter- mediary can control the risks associated with its aggregate portfolio, thus offering its investors (e.g. depositors of banks) more secure returns. 4. Delegated monitoring controls that serve to manage the incentives of borrowers, to ensure good behaviour 5. Dissemination of information collecting and presenting information to guide investors in their decisions Financial intermediaries: banks and others Institutions evolve to perform the functions adapt to changing circumstances, e.g. regulation, technology. 1 Banks exist in several varieties, with differing functions. Commercial banks are typical: accept depositors funds, which are then loaned out (deposits commonly being repayable on demand but loans of several months, or years, duration). In- vestment banks may not accept deposits at all but focus on providing services to corporations, e.g. arranging mergers, share-offerings, underwriting bond issues, organising take-over bids. Are (commercial) banks special? Creators of money? It is, at best, misleading to claim that banks are unique creators of money: their liabilities are widely accepted as a medium of exchange, a close substitute for state issued currency. Hence, banks actions can amplify or obstruct central bank monetary policy. Its a gross over- simplification to assert that banks can create money. Other financial intermediaries include insurance companies, hedge funds, private equity funds, pension funds, even financial exchanges. They perform various functions. Thus, for example, insurance companies carry out risk sharing, among other functions. 2 Bank risks: a Balance Sheet Approach Banks Balance Sheets Why look at a banks Balance Sheet? useful way of classifying risks of financial distress. Liabilities: Net Worth shareholders equity Net Worth is whats left over after subtracting the banks obligations from its assets; hence what is owed to the banks owners, or its capital; also interpreted as the value of the bank, noting that its the book value (estimated from the accounts) rather than the market value (which reflects shareholders estimates...
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This note was uploaded on 03/15/2012 for the course EC 372 taught by Professor R.e.bailey during the Spring '12 term at Uni. Essex.
- Spring '12