Professional Documents
Culture Documents
McGraw-Hill/Irwin
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Process
of Financial Intermediation
Different types of Intermediation and
various risks of Financial Intermediation.
Why
Key
Words/Terminologies/Glossary.
McGraw-Hill/Irwin
McGraw-Hill/Irwin
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FINANCIAL INTERMEDIATION
Financial
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McGraw-Hill/Irwin
Users of Funds
(Corporations)
Financial Claims
(Equity and debt
instruments or
securities)
Suppliers of
Funds
(Households)
Cash
Example: A firm sells shares or debentures directly to investors
without going through a financial institution.
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FIs Specialness
Without
Less liquidity
Substantial Price Risk
Maturity Mismatch Risk
High Default Risk/Credit Risk
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Users of Funds
Cash
FI
(Brokers)
McGraw-Hill/Irwin
Suppliers of Funds
FI
(Asset
transformers)
Financial Claims
(Equity and debt securities, loans
and mortgages etc.)
PRIMARY SECURITIES
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Cash
Financial Claims
(Deposits and insurance policies)
SECONDARY SECURITIES
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BENEFITS
With the Banks & FI Intermediation, enormous reduction in
the Search Costs, Monitoring Costs, Liquidity Risks, Price
Risks, Default Risks, Maturity Mismatch Risks, Transaction
Costs etc. facing the suppliers of funds compared to when
they directly invest in financial claims issued by the
ultimate fund users.
Because of diversification Bank is able to offer highly
liquid, instantly withdrawable demand deposits with
little price risk as liabilities while investing in risky,
non-tradable and often illiquid loans as assets.
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Functions of FIs
Brokerage
function
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Asset transformer:
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costs:
McGraw-Hill/Irwin
KINDS OF FINANCIAL
INTERMEDIATION
Banks and FIs actually performs various
kinds of intermediation. They are :
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Denomination Intermediation
Default-risk Intermediation
Maturity Intermediation
Liquidity Intermediation
Information Intermediation
Time Intermediation
Risk Pooling and Diversification (Economies of
Scale & Scope)
McGraw-Hill/Irwin
Interest
Interest Rate
Rate Risk
Risk
Foreign
Foreign Exchange
Exchange Risk
Risk
Market
Market Risk
Risk
Credit
Credit Risk
Risk
Liquidity
Liquidity Risk
Risk
Off-Balance-Sheet
Off-Balance-Sheet Risk
Risk
Technology
Technology Risk
Risk
Operational
Operational Risk
Risk
Country
Country or
or Sovereign
Sovereign Risk
Risk
Insolvency
Insolvency Risk
Risk
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Specialness of FIs
Liquidity
Reduced
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economies of scale
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Maturity intermediation
Transmission of monetary policy.
Credit allocation (Areas of special need such as
Priority Sector Loans including Agriculture
Loans, MSME loans, home loans, educational
loans, Export Credit etc.).
Intergenerational
transfers
or
time
intermediation.
Payment services (FedWire and CHIPS, in India
ECS, NEFT, RTGS & SWIFT).
Denomination intermediation.
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Reasons:
Special services provided by FIs in general.
Institution-specific
functions such as money
supply transmission (banks), credit allocation,
payment
& settlement services, capital
formation and economic development etc.
Negative externalities arise if these services are
not provided.
McGraw-Hill/Irwin
McGraw-Hill/Irwin
Regulation of FIs
Important
Primary role:
Ensure soundness of the system as a whole.
Regulation
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is not costless
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Regulation
Safety
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Regulation
Monetary
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policy regulation
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Regulation
Credit
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allocation regulation
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KEY WORDS/TERMINOLOGIES/GLOSSARY
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McGraw-Hill/Irwin