3 - Theoretical Perspectives on Banking and Financial System Structure

Summary

THE MODERN VIEW OF FINANCIAL INTERMEDIATION

Recent debate over the optimal structure of financial systems has produced a lively discussion over the motivation for and impact of universal banking, along with an active literature working to analyze institutional structure in the context of modern theories of corporate finance and banking. To understand the theoretical implications of universal banking, it is useful first to place these institutions in the more general context of financial intermediation.

The Existence and Functions of Intermediaries

Financial institutions intermediate between the sources and uses of financial capital in the economy. Financial intermediaries arise because they can provide these services at lower cost than individual savers and borrowers can on their own. In doing so, they may or may not change the fundamental characteristics of assets involved. They may, for example, simply broker transactions when the primary constraint on capital provision is the lack of information about opportunities: Those holding wealth are often unacquainted with those in need of funds. Much as a real estate agent facilitates the transfer of property, a financial intermediary can act as a broker simply by providing an easily identifiable place for buyers and sellers to transact. This service lowers transactions costs and broadens the accessibility of finance, thus raising the quantity of capital available.

The work of intermediaries also involves qualitative asset transformation (QAT), that is, changing the characteristics of financial claims.