BORGONIA,VIKTORIA VENICE

3030

OVERVIEW OF FINANCIAL INSTITUTIONS

Financial markets
-are imperfect
-there is information asymmetry therefore, risk is high
-because they are imperfect, we need FINANCIAL INSTITUTIONS

 FINANCIAL INSTITUTIONS
-they resolve the imperfections of the financial markets
-they accept FUNDS from the SURPLUS UNITS and channel these funds to the DEFICIT UNITS
-when it is time for the DEFICIT UNITS to repay, they channel this back to the SURPLUS UNITS to
give them back the return
-in effect, when the investors and borrowers meet, the financial institutions act as an
INTERMEDIARY so there is an INDIRECT TRANSFER
-ROLE: Institutions that perform the essential function of channeling funds from those with
surplus funds to those with shortage of funds

Specific Roles of Financial Institutions

 They offer deposit accounts that can accommodate the amount and liquidity
characteristics desired by most surplus units
 They repackage funds received from deposits to provide loans of the size and maturity
desired by deficit units
 They accept the risk on loans provided
 They have more expertise than individual surplus units in evaluating the
creditworthiness of deficit units
 They diversify their loans among numerous deficit units and therefore can absorb
defaulted loans better than individual surplus units could

Unique economic functions

1. MONITORING COSTS
 Financial institutions pool the resources of small savers, and because they
intermediate between savers and borrowers of all sizes, they can collect
information about deficit units at a relatively low average cost.
2. LIQUIDITY ANN PRICE RISK
 By pooling savings, financial institutions supply liquidity to the financial markets.
The size of financial institutions also put them in a better position to lessen price
risk.
 3. TRANSACTION COSTS
 This is an example of economies of scale. This simply means that financial
institutions have a cost advantage because it represents many savers and
borrowers.
4. MATURITY INTERMEDIATION
 Financial institutions can better bear the risk of mismatching their assets and
their liabilities. This means that financial institutions can afford to have liabilities
which are current (i.e. deposits from savers) & assets that are non current (i.e.
loans receivable from borrowers). This is because their sources of funds are as
varied as their users of funds.
5. DENOMINATION INTER MEDIATION
 Financial institutions such as mutual funds allow small investors to overcome
constraints to buying assets imposed by large minimum denomination size.

Services provided that benefit the overall company

1. MONEY SUPPLY TRANSMISSION
 Depository financial institutions channel the effects of monetary policies to the
entire financial system and economy.
2. CREDIT ALLOCATION
 Financial institutions are often viewed as a major source of financing for deficit
units.
3. INTERGENERATIONAL WEALTH TRANSFER
 This service is particularly true for insurance companies and pension funds,
which provides savers with the ability to transfer wealth from one generation to
another.
4. PAYMENT SERVICES
 The efficiency with which depository institutions provide payment services
directly benefits the economy.