Week 1 Flashcards
What is a relational contract?
Informal relationship between bank & borrowers, sustained by value of future relationships
How do relational contracts benefit banks?
Lower screening & monitoring costs for customers with history
How do relational contracts benefit customers?
Easier to get future loans at relatively low rates
What is the advantage of relational over transactional banking?
Information reusability mitigates info asymmetry + allows flexibility
What is transactional banking?
Securitisation transaction where bank acts as broker
What are the theories to explain financial intermediation?
- Delegated monitoring
- Information production
- Liquidity transformation
- Consumption smoothing
- Commitment mechanisms
What is the ‘delegated monitoring’ theory?
Intermediaries have economies of scale in monitoring borrowers on behalf of surplus units
What is the ‘information producing’ theory?
Intermediaries have economies of scale in gathering information about deficit units
What is the ‘liquidity transformation’ theory?
Banks hold illiquid assets & issue surplus units with liquid secondary claims
What is the ‘consumption smoothing’ theory?
Banks allow customers to save & consume smoothly despite life changes
What is the ‘commitment mechanisms’ theory?
Demand deposits limit bankers’ risk-taking
What are the benefits of financial intermediation to surplus units?
- More liquidity
- Less risk
- Marketable securities e.g. CDs
- Lower transaction costs
- Simpler decision-making
What are the benefits of financial intermediation to deficit units?
- Larger amounts
- Longer time periods
- Lower transaction costs
- Lower interest rates
- Available when needed
What are the benefits of financial intermediation to society?
- Funds utilised efficiently
- More borrowing & lending
- Funding for high-risk ventures, important to future growth
What are other names for shadow banking?
- Non-bank financial intermediation
- Market-based finance
What is shadow banking?
Bank-like activities (mainly lending) that take place outside traditional banking sector
What are the aspects of a bank’s transformation function?
- Size transformation
- Maturity transformation
- Risk transformation
True or false: banks play an important role in the transmission of monetary policy
True
What does OFI stand for?
Other financial institutions
What separates banks from OFIs?
They are DTIs (deposit-taking institutions)
What is a financial asset?
Claim for payment of future sum(s) of money
How can you identify a financial intermediary?
Deals mostly with financial assets & liabilities
Why are bilateral contracts illiquid?
They are unique / personalised
What is systemic risk?
Risk of problems spreading between institutions & markets, potentially causing collapse
Why say financial system instead of sector or industry?
Everything is highly interconnected
What are the main intermediary functions of a financial institution?
- Brokerage
- Asset transformation
When do financial institutions shift emphasis to the brokerage function?
When interest rates are low
What are the general functions of an intermediary?
- Pooling savers’ resources
- Safekeeping, accounting, payments
- Providing liquidity
- Diversifying risk
- Reducing information costs
What are examples of non-banks providing payment services?
- Google Pay
- Apple Pay
- PayPal
What does it mean when financial institutions ‘diversify risk’?
They allow each depositor to invest in a very wide range of different loans
What do information asymmetries generate?
- Adverse selection - ex ante
- Moral hazard - ex post
- Agency (monitoring) costs
What does CCP stand for?
Central (Clearing) Counterparties
What are CCPs?
What is market failure?
Inefficient allocation of goods & services in free market
What is credit rationing?
Market failure where lenders are unwilling to lend at prevailing rate
