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Lecture Principles of money, banking, and financial markets (12th edition): Chapter 11 - Ritter, Silber, Udell

Chapter 11 - The nature of financial intermediation. In this chapter you will learn to explain the benefits of financial intermediation and how it partially solves the adverse selection and moral hazard problems, understand the sale and history of commercial banking in the United States, describe the nondeposit financial intermediaries. | Chapter 11 The Nature of Financial Intermediation Copyright © 2009 Pearson Addison-Wesley. All rights reserved. Learning Objectives • Explain the benefits of financial intermediation and how it partially solves the adverse selection and moral hazard problems • Understand the role and history of commercial banking in the United States • Describe nondeposit financial intermedaries Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 11-2 The Economics of Financial Intermediation • In a world of perfect financial markets there would be no need for financial intermediaries (middlemen) in the process of lending and/or borrowing – Costless transactions – Securities can be purchased in any denomination – Perfect information about the quality of financial instruments Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 11-3 1 The Economics of Financial Intermediation (Cont.) • Reasons for Financial Intermediation – Transaction costs • Cost of bringing lender/borrower together • Reduced when financial intermediation is used • Relevant to smaller lenders/borrowers – Portfolio Diversification • Spread investments over larger number of securities and reduce risk exposure • Option not available to small investors with limited funds • Mutual Funds—pooling of funds from many investors and purchase a portfolio of many different securities Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 11-4 The Economics of Financial Intermediation (Cont.) • Reasons for Financial Intermediation (Cont.) – Gathering of Information • Intermediaries are efficient at obtaining information, evaluating credit risks, and are specialists in production of information – Asymmetric Information • Buyers/sellers not equally informed about product • Can be difficult to determine credit worthiness, mainly for consumers and small businesses Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 11-5 The Economics of Financial Intermediation (Cont.) • Reasons