The Concepts of Financial Intermediation Essay Example | Topics and Well Written Essays - 2500 words

The Concepts of Financial Intermediation - Essay Example A lot of these imperfections lead to particular types of transaction costs. These asymmetries can produce unfavourable selection, they can be temporary, generate moral exposure, and they can result a costly verification and enforcement. Based on studies, financial intermediaries emerge to at least partially overcome these costs. Leland and Pyle (32) interpreted financial intermediation as a coalition of sharing information. And intermediary coalitions according to Diamond (51) can achieve economies of scale. He also envisioned that financial intermediaries act on behalf of ultimate savers by effectively monitoring returns. According to Hart (1995), savers positively value the intermediations in terms of ultimate investments. On banker's behalf, according to Campbell and Kracaw (863-882) financial intermediations can create a constructive incentive result of short-term debt. The deposit finance can produce the right incentives for the management of the bank. A delicate financial structure needed to discipline the bank managers resulted illiquid assets (Diamond 393; Miller 21). In cases wherein the bank borrower preferred direct finance; financial intermediaries still act as a brokerage which was explained by Fama (39-58) as investment banks. In this, reputation is at stake and according to Campbell and Kracaw (885) in financing, the borrower's reputation as well as the financier is relevant. B. The transaction costs approach argument- This approach does not disagree with the statement of complete markets unlike the first approach mentioned. It is in accordance with a no convexities transaction process. The financial intermediaries in this approach work as alliances of borrowers who make use of economies of scale in the transaction process. According to many experts, the concept of transaction costs covers not only monetary transaction costs, but also searches, auditing and monitoring costs. In this instance, the function of the financial intermediaries is to convert particular financial claims into a so-called qualitative asset transformation. Ross (23-40) called it offering liquidity and diversified opportunities. The stipulation of liquidity is a key function for investors and savers and highly for corporate customers, in which the stipulation of diversification is being appreciated in institutional as well as personal financing. This liquidity should play a key role i n asset pricing theory (Oldfield and Santomero WP #95). With transaction costs the basis for the existence of financial intermediation is exogenous. C. Approach based on the regulation of money production - Regulation influences liquidity and solvency within the financial organization or market. It is argued that the capital of the bank affects its refinancing ability, bank safety, and ability to extract repayment from the borrowers (Diamond 414). Regulation as viewed on the basis of legality convenes as a vital factor in financial economy. However, the actions of the intermediaries intrinsically need regulation. The reason is that the banks specifically, are intrinsically illiquid and