Microeconomic Foundations of Financial Intermediaries
SUMMARY AND OUTLOOK 230
230 Summary and Outlook Summary and Outlook Why do banks exist, or more generally: why do third parties interpose themselves as intermediaries between final borrowers and final lenders? In a perfect Arrow-Debreu world, intermediaries are not needed to fulfill the functions cited in the literature, namely the transformation of maturities, lot sizes and risks, because a complete set of contingent contracts for all possible states of the world allows the economic units to make provisions for all eventualities. Any explanation of the existence of financial intermediaries must therefore take as its point of departure deviations from the conditions under which this model world is valid. However, various kinds of friction alone are not sufficient to explain the existence of financial intermediaries. These frictions can be, and indeed are, overcome by using the appropriate instruments. It is only when the reduction of transaction costs incurred in the application of these instruments is also assumed to be a goal of the economic units that an explanation for the existence of financial intermediaries becomes possible. Of the major deviations from the conditions of the Arrow-Debreu world, the most relevant contingencies are asymmetrically distributed information, problems concerning the enforceability of contracts, and fundamental uncertainty. In Chapter 1, we assumed that firms have various qualities which cannot be observed by the lender. This informational asymmetry ex ante, i.e. prior to conclusion of a contract, may - in the absence of any kind of mechanism for solving the problem - cause the market to collapse due...
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