Lectures Flashcards
What is a bank?
An institution whose current operations consist of granting loans and receiving deposits from the public
What mechanism do banks provide?
They transfer and efficiently allocate surplus funds from savers to borrowers
Do we really need banks?
Yes we do! They bridge the gap between borrowers and lenders and reconcile their often incompatible needs and objectives
What are the lenders’ and borrowers’ incompatible needs?
Timings
Length of loan
Liquidity
Low cost funds etc
What is indirect finance?
Raising capital through financial intermediaries (banks)
What is direct finance?
Borrowers borrow directly from the financial market
What are the roles of banks?
Provide liquidity
Transforming asset
Managing risk
Processing information
What is maturity transformation?
Banks transform funds lent for short periods of time into securities with long term maturities i.e. loans
What is size transformation?
Generally deposits are smaller than the loans that people require. Banks repackage smaller loans into larger ones
How do banks manage risk?
They diversify their investments
Screen and monitor borrowers
Hold capital reserves
What is their processing information and monitoring role?
Banks have a role in managing problems resulting from imperfect information on borrowers. They invest in IT to better screen clients. Long term relationships let’s them cumulate into to mitigate moral hazard
Fundamentally why do banks exist?
Delegated monitoring - expertise and economies of scale in processing risk information.
Information production - there would be duplication of information if people acted individually.
Liquidity transformation - turn liquid deposits into illiquid assets
Consumption smoothing - they provide liquidity whenever it’s needed
Would banks exist in a frictionless world?
No
What is a frictionless economy called?
Arrow-Debreu
Why do banks exist? Leland Pyle
Information sharing coalitions
Financial intermediation as delegated monitoring
Liquidity
