Ngân hàng, tín dụng - Chapter 11: The nature of financial intermediation

1Copyright © 2009 Pearson Addison-Wesley. All rights reserved. Chapter 11 The Nature of Financial Intermediation Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 11-2 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. 11-3 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 2Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 11-4 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. 11-5 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. 11-6 The Economics of Financial Intermediation (Cont.) • Reasons for Financial Intermediation (Cont.) – Asymmetric Information (Cont.) • Borrower knows more than lender about borrower’s future performance • Borrowers may understate risk • Asymmetric information is much less of a problem for large businesses—more publicly available information 3Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 11-7 The Economics of Financial Intermediation (Cont.) • Reasons for Financial Intermediation (Cont.) – Adverse Selection • Related to information about a business before a financial transaction is consummated • Occurs when an individual or group who is most likely to cause an undesirable outcome are also the most likely to engage in a market • Small businesses tend to represent themselves as high quality Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 11-8 The Economics of Financial Intermediation (Cont.) • Reasons for Financial Intermediation (Cont.) – Adverse Selection (Cont.) • Banks know some are good and some are bad, how to decide – Charge too high an interest, good credit companies look elsewhere—leaves just bad credit risk companies – Charge too low interest, have more losses to bad companies than profits on good companies – Market failure—Banker may decide not to lend money to any small businesses Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 11-9 The Economics of Financial Intermediation (Cont.) • Reasons for Financial Intermediation (Cont.) – Moral Hazard • Occurs after a transaction is consummated • One party acts in a way contrary to the wishes of the other party • Arises if it is difficult or costly to monitor each other’s activities • Taking risks works to owners advantage, prompting owners to make riskier decisions than normal – Owner may “hit the jackpot”, however, bank is not better off – From owner’s perspective, a moderate loss is same as huge loss—limited liability 4Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 11-10 The Economics of Financial Intermediation (Cont.) • Summary of role of financial intermediaries in flow of information (Figure 11.1) – Case 1 • Funds flow from savers/lenders through financial intermediaries (banks) to borrowers/spenders • The financial intermediary issues nontraded contracts to the borrowers • Primarily in the form of bank loans held to maturity • Banks monitor borrower behavior over life of loan Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 11-11 The Economics of Financial Intermediation (Cont.) • Summary of role of financial intermediaries in flow of information (Figure 11.1) – Case 2 • Funds flow from the financial intermediaries to financial markets who lend to borrowers/spenders • In this case, the lending takes the form of traded contracts between the financial market and borrowers • An example of this case would be money market mutual funds Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 11-12 The Economics of Financial Intermediation (Cont.) • Summary of role of financial intermediaries in flow of information (Figure 11.1) – Case 3 • In this case, funds flow directly through financial markets to borrowers/spenders in the form of traded contracts • Financial intermediaries are not involved in this transaction • Purchase of stocks/bonds by individuals in financial markets 5Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 11-13 FIGURE 11.1 Flow of funds from savers to borrowers. Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 11-14 The Evolution of Financial Intermediaries in the US • The institutions are very dynamic and have changed significantly over the years • Refer to Table 11.1 and 11.2 for relative importance of different types of institutions and how this has changed from 1960 to 2008 – Winners—Pension funds and mutual fund – Losers—Depository institutions (except credit unions) and life insurance companies Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 11-15 TABLE 11.1 Financial Intermediary Assets in the United States, 1960–2007 (in billions of dollars) 6Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 11-16 TABLE 11.2 Share of Financial Intermediary Assets in the United States, 1960–2007 (percent) Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 11-17 The Evolution of Financial Intermediaries in the U.S. (Cont.) • Changes in relative importance caused by – Changes in regulations – Key financial and technological innovations • Shifting Sands of Interest Rates – 1950s and early 1960s • Stable interest rates • Fed imposed ceilings on deposit rates • Little competition for short-term funds from small savers • Many present day competitors had not been developed • Therefore, large supply of cheap money Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 11-18 The Evolution of Financial Intermediaries in the U.S. (Cont.) • Shifting Sands of Interest Rates (Cont.) – Mid-1960’s • Growing economy meant increased demand for loans • Percentages of bank loans to total assets jumped from 45% in 1960 to nearly 60% in 1980 • Challenge for banks was to find enough deposits to satisfy loan demand – Interest rates became increasingly unstable – However, depository institutions still fell under protection of Regulation Q 7Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 11-19 The Evolution of Financial Intermediaries in the U.S. (Cont.) • The Regulation Q Security Blanket – Provisions and Intent of Regulation Q • Fed had responsibility of imposing ceilings on deposit interest rates • Promote stability in banking industry • Prevent “destructive” competition among depository institutions to get funds by offering higher deposit rates • Higher cost of funds would increase costs and increase bank failures Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 11-20 The Evolution of Financial Intermediaries in the U.S. (Cont.) • The Regulation Q Security Blanket (Cont.) – Consequences of Regulation Q • Rising short-term interest rates meant depository institutions could not match rates earned in money market instruments such as T-bills and commercial paper • However, option was not opened to small investor—money market instruments were not sold in small denominations • Financial disintermediation—Wealthy investors and corporations took money from depository institutions and placed in money market instruments Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 11-21 The Evolution of Financial Intermediaries in the U.S. (Cont.) • Birth of the Money Market Mutual Fund – Figure 11.2 traces history of short-term interest rates and the Regulator Q ceiling rates on passbook savings accounts from 1950 to 2002 – In 1961 banks were permitted to offer negotiable certificates of deposit (CDs) in denominations of $100,000 not subject to Regulation Q – In mid-1960s short-term rates became more volatile and wealthy investors switched from savings accounts to large CD’s 8Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 11-22 FIGURE 11.2 Interest rates and Regulation Q. Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 11-23 The Evolution of Financial Intermediaries in the U.S. (Cont.) • Birth of the Money Market Mutual Fund (Cont.) – In 1971 Money Market mutual Funds were developed and were a main cause in the repeal of Regulation Q • Small investors pooled their funds to buy a diversified portfolio of money market instruments • Some mutual funds offered limited checking withdrawals • Small investors now had access to money market interest rates in excess permitted by Regulation Q Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 11-24 The Evolution of Financial Intermediaries in the U.S. (Cont.) • The Savings and Loan (S&L) Crisis – Figure 11.3—As interest rates rose in late 1970s, small investors moved funds out of banks and thrifts – Beginning of disaster for S&Ls since they were dependent on small savers for their funds 9Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 11-25 FIGURE 11.3 Commercial paper and money market mutual funds (billions of $ outstanding). Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 11-26 The Evolution of Financial Intermediaries in the U.S. (Cont.) • The Savings and Loan (S&L) Crisis (Cont.) – Depository Institutions Deregulation and Monetary Control Act of 1980 and the Garn-St. Germain Depository Institutions Act of 1982 • Dismantled Regulation Q • Permitted S&Ls (as well as other depository institutions) to compete for funds as money market rates soared Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 11-27 The Evolution of Financial Intermediaries in the U.S. (Cont.) • The Savings and Loan (S&L) Crisis (Cont.) – However, the financial makeup of S&Ls changed significantly • Most of their assets (fixed-rate residential mortgages, 30 year) yielded very low returns • Interest paid on short-term money (competing with mutual funds) was generally double the rate of return on mortgages • Market value of mortgages held by S&Ls fell as interest rates rose making the value of assets less than value of liabilities 10 Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 11-28 The Evolution of Financial Intermediaries in the U.S. (Cont.) • The Savings and Loan (S&L) Crisis (Cont.) • Since financial statements are based on historical costs, extent of asset value loss was not recognized unless mortgage was sold • Under the Garn-St. Germain Act, S&Ls were permitted to invest in higher yielding areas in which they had little expertise (specifically junk bonds and oil loans) • Investors were not concerned because their deposits were insured by Federal Savings and Loan Insurance Corporation (FSLIC) • Result is an approximate $150 billion bail-out—paid for by taxpayers Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 11-29 The Evolution of Financial Intermediaries in the U.S. (Cont.) • The Rise of Commercial Paper – Financial disintermediation created situation where corporations issued large amounts of commercial paper (short-term bonds) to investors moving funds away from banks – This growth paralleled the growth in the money market mutual funds—Figure 11.3 Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 11-30 The Evolution of Financial Intermediaries in the U.S. (Cont.) • The Rise of Commercial Paper (Cont.) – Banks lost their largest and highest quality borrowers to commercial paper market – To compensate for this loss of quality loans, banks started making loans to less creditworthy customers and lesser developed countries (LDC’s) – As a result, bank loan portfolios became riskier in the end of 1980s 11 Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 11-31 The Evolution of Financial Intermediaries in the U.S. (Cont.) • The Rise of Commercial Paper (Cont.) – The increase in commercial paper was aided by technological innovations • Computers and communication technology permitted transactions at very low costs • Complicated modeling permitted financial institutions to more accurately evaluate borrowers—addressed the asymmetric problem • Permitted banks to more effectively monitor inventory and accounts receivable used as collateral for loans Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 11-32 The Evolution of Financial Intermediaries in the U.S. (Cont.) • The Institutionalization of Financial Markets – Institutionalization—more and more funds now flow indirectly into financial markets through financial intermediaries rather than directly from savers – These “institutional investors” have become more important in financial markets relative to individual investors – Easier for companies to distribute newly issued securities via their investment bankers Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 11-33 The Evolution of Financial Intermediaries in the U.S. (Cont.) • The Institutionalization of Financial Markets (Cont.) – Reason for growth of institutionalization • Growth of pension funds and mutual funds • Tax laws encourage additional pensions and benefits rather than increased wages 12 Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 11-34 The Evolution of Financial Intermediaries in the U.S. (Cont.) • The Institutionalization of Financial Markets (Cont.) • Legislation created a number of new alternatives to the traditional employer-sponsored defined benefits plan, primarily the defined contribution plan – IRAs – 403(b) and 401(k) plans – Growth of mutual funds resulting from the alternative pension plans—Mutual fund families Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 11-35 The Evolution of Financial Intermediaries in the U.S. (Cont.) • The Transformation of Traditional Banking – During 1970s & 80s banks extended loans to riskier borrowers – Especially vulnerable to international debt crisis during 1980s – Increased competition from other financial institutions – Figure 11.4, shows failures of banks during late 1980s & early 1990s Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 11-36 FIGURE 11.4 Commercial bank failures. 13 Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 11-37 The Evolution of Financial Intermediaries in the U.S. (Cont.) • The Transformation of Traditional Banking (Cont.) – Predictions of demise of banks are probably exaggerated • Although banks’ share of the market has declined, bank assets continue to increase • New innovation activities of banks are not reflected on balance sheet – Trading in interest rates and currency swaps – Selling credit derivatives – Issuing credit guarantees Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 11-38 The Evolution of Financial Intermediaries in the U.S. (Cont.) • The Transformation of Traditional Banking (Cont.) – Predictions of demise of banks are probably exaggerated (Cont.) • Banks still have a strong comparative advantage in lending to individuals and small businesses – Banks offer wide menu of services – Develop comprehensive relationships—easier to monitor borrowers and address problems • In 1999 the Gramm-Leach-Bliley Act repealed the Glass-Steagall Act of 1933 permitting the merging of banks with many other types of financial institutions, thereby insuring the continuation of banks Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 11-39 Financial Intermediaries: Assets, Liabilities, and Management • Unlike a manufacturing company with real assets, banks have only financial assets • Therefore, banks have financial claims on both sides of the balance sheet – Credit Risks • Banks tend to hold assets to maturity and expect a certain cash flow • Do not want borrowers to default on loans • Need to monitor borrowers continuously – Charge quality customers lower interest rate on loans – Detect possible default problems 14 Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 11-40 Financial Intermediaries: Assets, Liabilities, and Management (Cont.) – Interest Rate risks • Vulnerable to change in interest rates – Want a positive spread between interest earned on assets and cost of money (liabilities) – Attempt to maintain an equal balance between maturities of assets and liabilities – Adjustable rate on loans, mortgages, etc. minimizes interest rate risks Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 11-41 Financial Intermediaries: Assets, Liabilities, and Management (Cont.) • Figure 11.5 shows condensed balance sheets (T- accounts) for some of the major financial intermediaries in the U.S. – Assets on the left-hand side and liabilities and equity are on the right-hand side – Depository Institutions • All have deposits on the right-hand side of balance sheet • Investments in assets tend to be short term in maturity • Do face credit risk because they invest heavily in nontraded private loans Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 11-42 FIGURE 11.5 Selected intermediary balance sheets. 15 Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 11-43 Financial Intermediaries: Assets, Liabilities, and Management (Cont.) – Non-depository Financial Intermediaries • Some experience credit risk associated with nontraded financial claims • Asset maturities reflect the maturity of liabilities – Insurance and pension funds have long-term policies and annuities—invest in long-term instruments – Consumer and commercial finance companies have assets in short-term nontraded loans—raise funds by issuing short-term debt