
Chapter6The Economics ofFinancialIntermediationMcGraw-Hilly/rwinCopyright 2006byTheMcGraw-Hill Companies,Inc.All rights reserved
McGraw-Hill/Irwin Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 6 The Economics of Financial Intermediation

CONTENS86.1FlowofFunds:Directand IndirectFinance6.2RoleofFinancialIntermediation6.3InformationAsymmetriesandInformationCosts11-2
11-2 CONTENS 6.1 Flow of Funds: Direct and Indirect Finance 6.2 Role of Financial Intermediation 6.3 Information Asymmetries and Information Costs

6.1 Flow of Funds:DirectCand Indirect FinanceaTable 11.1The Relative Importance of Directand IndirectFinance(Averagesfor1980-1995)Direct FinanceIndirect FinanceCredit ExtendedRatioofStock MarketOutstandingIndirectbyBanks&OtherFinancialto DirectCapitalizationDomestic DebtFinanceas PercentSecurities asInstitutions asofGDPPercentof GDPPercentof GDPC/(A+B)(A)(C)(D)(B)CountryIndustrialized Countries1.5France19.8%41.2%90.9%1.618.637.492.3Germany8.14.340.23.2Greece11.9Italy28.150.51.373.030.0169.31.6Japan74.40.876.314.4United Kingdom1.258.252.6130.7United StatesEmerging Markets Countries5.94.815.01.4Argentina1.6Brazil11.94.024.75.7India13.226.81.411-3
11-3 6.1 Flow of Funds: Direct and Indirect Finance

6.2 Five Roles ofC8FinancialIntermediariesPooling SavingsSafekeepingand AccountingProviding LiquidityRisksharingInformationServices11-4
11-4 6.2 Five Roles of Financial Intermediaries Pooling Savings Safekeeping and Accounting Providing Liquidity Risk sharing Information Services

ASummaryoftheRoleofCOOFinancial Intermediaries3.Providing Liquidity: Allowing depositors totransform their financial assets into money quicklyeasily, and at low cost.4.Risk sharing: Providing investors with the ability todiversify even small investments.5. Information Services: Collecting and processinglarge amounts of standardized financial information11-5
11-5 A Summary of the Role of Financial Intermediaries 3.Providing Liquidity: Allowing depositors to transform their financial assets into money quickly, easily, and at low cost. 4.Risk sharing: Providing investors with the ability to diversify even small investments. 5. Information Services: Collecting and processing large amounts of standardized financial information

ASummaryof theRoleofCOFinancial Intermediaries1.Pooling Savings: Accepting resources from alarge number of small savers/lenders in orderto provide large loans to borrowers.2.Safekeeping and Accounting: Keepingdepositors' savings safe, giving them access tothe payments system, and providing them withaccounting statements that help them to tracktheir income and expenditures11-6
11-6 A Summary of the Role of Financial Intermediaries 1.Pooling Savings: Accepting resources from a large number of small savers/lenders in order to provide large loans to borrowers. 2.Safekeeping and Accounting: Keeping depositors’ savings safe, giving them access to the payments system, and providing them with accounting statements that help them to track their income and expenditures

6.3InformationAsymmetriesandCInformationCosts1. asymmetric informationissuers offinancial instruments-borrowerswho want to issue bonds and firms that wantto issue stock - know much more about theirbusinessprospectsandtheirwillingnesstoworkthanpotential lenders or investors11-7
11-7 6.3 Information Asymmetries and Information Costs • 1. asymmetric information • issuers of financial instruments – borrowers who want to issue bonds and firms that want to issue stock – know much more about their business prospects and their willingness to work than potential lenders or investors

InformationAsymmetriesand福OInformationCosts2. Adverse Selectionpotential borrowers know more about theprojects they wish to finance than prospectivelenders11-8
11-8 Information Asymmetries and Information Costs • 2. Adverse Selection • potential borrowers know more about the projects they wish to finance than prospective lenders

InformationAsymmetriesandCCOInformation CostsIf you can't tell the difference between the twofirms' prospects, you will be willing to pay a pricebased only on the firms' average quality.The result is that the stock of the good companywill be undervalued.Since the managers know their stock is worthmore than the average price, they won't issuethe stock in the first place.That leaves only the firm with bad prospects inthe market.11-9
11-9 Information Asymmetries and Information Costs • If you can’t tell the difference between the two firms’ prospects, you will be willing to pay a price based only on the firms’ average quality. • The result is that the stock of the good company will be undervalued. • Since the managers know their stock is worth more than the average price, they won’t issue the stock in the first place. • That leaves only the firm with bad prospects in the market

InformationAsymmetriesandOInformationCosts3. Solving the Adverse Selection ProblemDisclosure of InformationCollateral and Net Worth11-10
11-10 Information Asymmetries and Information Costs • 3. Solving the Adverse Selection Problem • Disclosure of Information • Collateral and Net Worth