Financial Asymmetry And Agency Theory: The Theory Of Financial Intermediaries

1. A financial intermediary is a corporation that takes funds from investors and then provides those funds to those who need capital. A bank that takes in demand deposits and then uses that money to make long-term mortgage loans is one example of a financial intermediary.

In the most basic definitions of economics, the United States’s Financial system is broken down into approximately five groups: the households, the firms, the market for factors of production, the market of goods and services, and the government. Within these groups, there is a constant flow that progresses in a circle through all of these groups in order to keep the economy running smoothly. This system is based on the notion that both consumers and producers need to come together to transact. However, buyers don’t always have the money they need to buy supplies, and sellers don’t always have the money to produce products or provide services. When this occurs, it is important for both investors and banks to offer aid in order to prevent

Transparency is essential in a market based system, but is not necessarily a requirement for a bank-based system. In a bank based system, banks have long-standing working relationships with the companies seeking financing, and banks have on-going access to information about the firm. In a market based system, creditors and equity-holders require that financial information about companies seeking financing be available, sufficiently detailed and accurate if they are to participate in the market. This information, including audited financial statements, allows participants in the market to make

All in all, I aim to assist in creating an illuminating understanding on American financial system and reforms through this public policy paper.

The Glass-Steagall Act of 1933 that defined the roles for commercial banks, investments banks and insurance firms was over ridden by the Gramm-Leach-Bliley Act (1999) which repealed the provisions that restricted affiliations in financial institutions. Hence one solution is to overcome the incentive problem and the conflict of interests that arise when financial institutions simultaneously undertake financial activities of varied nature.

The requirement of central clearing promotes transparency, and “skin in the game” rule encourages banks to take less speculation, and a more standardized and transparent market will be formed in US. As a result, with better regulated financial system and more sophisticated investment protection, America magnetizes more international capital flows, which boost the development of US financial institutions. In the meanwhile, other countries tend to follow the US regulation standard, improving market discipline of global financial institutions. However, magnates in financial industry with unchanged risk-taking tendency can manipulate their leverage ratio, and the credibility of information they state can be

Financial intermediaries are financial institutions such as bank, insurance company, credit union, stock exchange, and so on who works as a middleman

11. Peter J. Wallison. Hidden in Plain Sight. New York, NY: Encounter Books, 2015, 17. the major functions provided by big banks into different organizations be reconsidered?12

Supervisory and regulatory structures have in the past failed to control the activities of these enormous companies dealing in financial solutions especially where these organizations have become larger than the country’s individual economies. The financial companies engage in risks too large for them to handle in a bid to generate more profits and when these ventures have gone haywire, these companies have sunk.

The bank-lending channel underpins the role of banks as financial intermediaries, as their business structure is designed to serve certain type of borrowers, being small to mid-sized enterprises and households, where the problem of asymmetric information emerge \citep{stiglitz81}. According to the theory,

The investment banks, and subsequent stock brokerage firms, was regulated by the Security and Exchange Commission. The banking entities, in this portion of the financial sector, were used to dealing in high risk business that were structured on the business’ equity and debt capital, instead of the commercial banks’ deposits of customers. The activities in this sector of the financial system were underwriting stocks and bonds, insurance markets, the investments in subprime debt markets and mortgages.

List of abbreviations List of tables Acknowledgements Abstract 1. 2. 3. 4. 5. 6. 7. 8. Introduction Problem statement Objectives and hypothesis of the study Literature review Structure and performance of the financial sector in

A: Most investments in the economy would fail to take place if there were no financial institutions because many independent investors do not like to take large amounts of risk. By utilizing financial intermediaries, which are “organizations that receive funds from savers and channel them to investors,” people are given peace of mind in knowing that their source of money/investing is more stable and accounted for. Those who apply this principle also value the liquidity, or convertibility, that financial institutions provide in the case of emergency or cold feet.

The global market has shown exemplary contribution to the growth of the world's development until recently where financial crisis have been bombarding most economies. As a result, the cost of livelihood had been unaffordable to many who live below the dollar. The monetary crisis has led to the lowering of many currencies against the dollar, hence advancing the economy crisis to most worldwide nations. This turn of events has been attributed to the lack of exercise of business and management ethics in many multinational companies, firms and investments. Financial scandals have been the order of the past twenty years leading to the sweep over of the flourishing global market. The scandals, especially in larger companies and multinational, are spurred by inter and intra-conflicts in their organizational structures.

Financial intermediaries provide a number of functions. The first of which is known as size transformation. A financial intermediary is able to borrow to an economic agent with a deficit of funds the amount they require without the need to find a lender that is willing to invest the exact amount required by the borrower. Without financial intermediaries, it would be extremely difficult for a borrower to raise capital as lenders would have to pool their funds together in order to lend the borrower the amount they require. Another function of financial intermediaries is maturity transformation. Economic agents with surplus funds usually prefer investing their money in short-term projects, whereas borrowers require more long-term financing. Financial intermediaries offer an optimal solution, without which borrowers and lenders would be in disagreement over the terms of the transfer of funds. Financial intermediaries also provide risk transformation. Economic agents with surplus funds are usually very risk conscious when it comes to investment, but borrowers however may require the finance for a more risky project, that may be more profitable. Financial intermediaries are willing to take risks that borrowers usually would not. However, there is usually a compensation agreement so as to avoid