Chapter 8 1. Define and give and example of two types of asymmetric information problems. Comment on the (principal-agent problem) - While conducting a transaction between two businesses or any borrower and lender, asymmetric information means one side of the transaction may have more information than the other. The two problems that come with asymmetric information are moral hazard and adverse selection. The principal-agent problem is basically when regulator specialist is hired to make sure that moral hazard occurrence doesn’t happen. The problem arises when this regulator accepts incentives to keep moral hazard and adverse selection under wraps when it happens. 2. What specific procedures do financial intermediaries use to reduce asymmetric information problems in lending? - Financial intermediaries do a lot of monitoring on the borrower after a loan is made. They look at many aspects to make sure that the borrower is using the loan to solely benefit the main reason for the loan and nothing else. 3. Describe two ways in which financial intermediaries help lower transaction costs in the economy. - The first way is to give investors and borrowers the opportunity to take advantage of the Economies of Scale system. The other way intermediaries help lower transaction costs is by allowing fast contact access developed by a process called Expertise. 4. What is the free-rider problem? How does the free-rider problem aggravate adverse selection and moral hazard problems
When consumers use a debit or credit card for the purchase of interchange fees paid by the merchant's bank (the buyer) to the consumer's bank (issuer). The level of interchange fees is will determine a fee relatives faced with cardholders compared to stores. The interchange fee is higher, causing the cost of acquirers charge merchants to more efficiently and reduce the costs of issuers to cardholders charging less. (Or in fact, give them a discount)
The regulation that I have chosen for this paper is amendment in the Regulation X i.e. “Real Estate Settlement Procedures Act” and Regulation Z which is for “Truth in Lending”, for establishing the new disclosure requirements and forms in Regulation Z for the most closed-end consumer credit transactions secured by the real property. This regulation is controlled by the Bureau of Consumer Financial Protection. The role of the Consumer Financial Protection Bureau (CFPB) is to provide consumers information related to the terms of their agreements with financial companies during their application for a mortgage, choosing among credit cards, or using any number of other consumer financial products. The mortgage market is the single largest market for the consumer of financial products and the services in the United States, with approximately $10.4 trillion in loans outstanding. Since last decade, market went through an unprecedented cycle of the expansion and the contraction that was fuelled in the part by securitization of mortgages and the creation of increasingly sophisticated derivative products. This led to the collapse of financial system in 2008 and sparked the most severe recession in United States.
The other financial intermediaries include insurance companies, mutual funds and pension funds. In Japan, banks provide more financing than other financial intermediaries do. In the U.K., other financial intermediaries provide substantially more financing. In the U.S., banks are less important sources of financing compared to financial intermediaries. While in Europe, financing provided by banks and financing provided by other financial intermediaries are approximately equal.
As competition increased between savings and loans, banks, and credit unions, banks were eager to attract loan applicants in order to increase revenue and compete with other financial institutions. Jack S. Light, the author of Increasing Competition between Financial Institutions, said in his book that “commercial banks are diversifying their assets toward higher percentages of mortgages and consumer loans, and thrift institutions are seeking authority to diversify their loan structures. Moreover, mounting pressures are working toward, and have partially succeeded in, changing the authority of thrifts to include third-party payment accounts similar to commercial bank demand deposits.” (Light) Because of this eagerness to bring in new clients, they were willing to give out loans without checking into the financial stability of the borrower or the business that was requesting the loan. Unfortunately since the banks didn 't look into their clients’ financials adequately, many clients defaulted on their loans because they could not afford the payments, especially when balloon payments started.
As with any financial information collected we need to ensure that the customers information is kept safe and secure and the information we gather follow the proper collection regulations. We need to disclose to the customer the ways we intend to use the information, such as running credit checks or opening lines of credit. Prior to the customer submitting any information we need to ensure that we disclose this information.
Asymmetric information in lending is a huge risk. When there is misinformation from a lender to a borrower, this can cause a few different problems to arise; for example misinformation about job security or credit history from a borrower to a lender can result in late or missed payments, fraudulent spending of the money lent or the lending amount to be turned as bad debt. Specialization is a tool used for risk management. Specialization in lending helps reduce risk by gathering valuable and accurate information about the borrower. It
Asymmetric information is defined by a situation in which one party in a transaction has more or superior information compared to another. (Asymmetric information) This often happens in transactions where the seller knows more than the buyer, but the reverse happens as well. Potentially, this could be a harmful situation because one party can take advantage of the other party's lack of knowledge. In the healthcare world, this can happen when the patients know very little about what the doctors give them so the patient “puts his trust in doctor’s wisdom and his money in doctor’s pocket.” (Frakt)
From time to time, lenders and their attorneys announce that lender liability is no longer an issue with which the lending community needs to be concerned. What usually prompts this proclamation of the death of lender liability is a recent case in which a court has summarily rejected a borrower 's claim that the lender violated the duty of good faith and fair dealing. Many courts have rejected borrowers ' lawsuits which are based on allegations of the violation of the lender 's duty of good faith. Nevertheless, lender liability should continue to be an area of concern to lenders.
Information asymmetries is the process of deciding who has the best information regarding transactions. It can persuade a person to change their mind about something. We encounter information asymmetrics on a daily basis. For example, a person who is terminally ill and on the verge or dying will seek life insurance,
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.
* Not only do borrowing and lending rates differ due to taxes and transaction costs, but some individuals are screened out of legitimate credit markets altogether due to informational asymmetries
As technology improves, the wide use of “hard information”, such as the borrower’s credit history, reduces informational asymmetries. Therefore, long-distance small business lending is easier (Frame, Srinivasan, \& Woosley, 2001; Petersen \& Rajan, 2002). However, even with the use of credit score data, collecting ``soft information" still helps local lenders control risks to avoid delinquency (DeYoung, Glennon, \& Nigro, 2008) and provides informational advances in offering more favorable rates (Agarwal \& Hauswald, 2010).
Over the years, both lenders and borrowers have endeavoured towards the possibilities of fundamentally disrupting and disintermediating existential financial links, distancing themselves from the financial main, and building new financial operators.
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
Asymmetric information is the study of decision in transactions where one party gains more information than the other party. The theory of asymmetric information was first proposed in the 1970s and 1980s, it sometimes refers to as information failure and it is the contrast term to perfect information. Asymmetric information occurs whenever one party in an economic transaction appears to have greater knowledge than the other party engaged in the transaction. This normally explains itself when the seller (the first party) of a good or service possesses more information than the buyer (the second party), however, the opposite situation could be also possible like in the situation of financial market where the borrower (the second party) knows more information about his financial state than the lender (the first party). A good example of asymmetric information manifests in the situation of selling a car, in which the seller has the full knowledge of the car and its