CHAPTER 12
🏦 Financial Institutions and Intermediaries
I. Financial Institutions and the Financial System
Financial Institution (FI): A company dealing with financial and
monetary transactions (deposits, loans, investments).
Examples include banks, insurance companies, and brokerage
firms.
Function of FIs: Provide essential services to almost everyone in
developed and developing economies, operating from local credit
unions to international investment banks.
The Financial System's Two Channels:
1. FinancialMarkets: Direct flow of funds from savers to
borrowers (e.g., Stock Exchanges).
2. Financial Intermediaries: Indirect flow of funds, transforming
assets (e.g., Banks).
II. The Role of Financial Intermediaries (FIs)
Financial Intermediation: The process of taking funds from
savers and channeling them to borrowers.
* Benefits of FIs: Solve three major problems in the flow of
funds:
* Transaction Costs: FIs reduce costs through economies of
scale (e.g., providing standardized contracts).
* Risk Sharing (Asset Transformation): FIs create assets
that are less risky for savers (liabilities) than the assets FIs hold
(loans).
* Asymmetric Information: FIs reduce the risk of adverse
selection and moral hazard.
III. Categorization of Financial Intermediaries
FIs are generally categorized based on their primary source of
funds (liabilities) and use of funds (assets).
A. Depository Institutions (Banks)
FIs that accept deposits from individuals and firms and
make loans.
Source of Funds (Liabilities): Primarily demand, savings, and
time deposits.
Use of Funds (Assets): Primarily commercial, consumer, and
mortgage loans.
B. Contractual Savings Institutions
FIs that acquire funds at periodic intervals (contracts) and
have predictable payout schedules, allowing them to invest in
long-term assets.
Source of Funds (Liabilities): Primarily premiums (Insurance)
and contributions (Pension).
Use of Funds (Assets): Primarily corporate bonds, stocks, and
mortgages.
C. Investment Intermediaries
Institutions that do not primarily accept deposits or rely on
long-term contracts.