24: Financial System and Economic Growth Flashcards
role of the financial system
channelling funds from households, businesses and governments with surplus funds to households, businesses and governments with a shortage of funds
direct finance
channels funds directly through the financial market
financial markets
- exchanges
- investment banking
financial instruments/securities
- equities
- bonds
indirect finance
channels funds through a financial intermediary
information challenges
financial intermediaries exist because of this
asymmetric information
free-rider problems
why does asymmetric information lead to a less efficient allocation of funds?
adverse selection
moral hazard
how do financial intermediaries solve asymmetric information problems?
issuing private loans to reduce free-rider problems
using credit standards to avoid adverse selection
imposing loan covenants to prevent moral hazard
role of the government
regulation
provision of a safety net
governments promoting transparency
disclosure of financial information from public firms
adherence to generally acceptable accounting standards
prudential regulation
rules the government sets to prevent banks from taking on too much risk
prudential supervision
activities the government engaged in to enforce prudential regulation
relationship between financial development and economic growth
increases in private credit lead to a more efficient allocation of credit, an increase in investment in more productive assets and faster economic growth