User name. Remember me. The role of banking intermediaries is to "intermediate" between players who are in financial deficit and those experiencing a surplus in order to resolve their need to invest available financial resources. People who are in financial deficit seek monetary resources by placing "liabilities" on the market and by offering them to those in surplus. The problem is therefore to reconcile the preferences expressed by buyers as compared with those made by the issuers of liabilities in terms of maturity, yield, value fluctuation, etc.
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User name. Remember me. The role of banking intermediaries is to "intermediate" between players who are in financial deficit and those experiencing a surplus in order to resolve their need to invest available financial resources. People who are in financial deficit seek monetary resources by placing "liabilities" on the market and by offering them to those in surplus.
The problem is therefore to reconcile the preferences expressed by buyers as compared with those made by the issuers of liabilities in terms of maturity, yield, value fluctuation, etc. Subjects in surplus have difficulties in identifying and evaluating the quality of those in deficit, they must take into account the uncertainty associated with future events, their degree of risk aversion and the preference of short-term assets.
On the other hand, those in deficit prefer to issue long term liabilities, not to disclose their quality of credit and, once obtained the funds, they prefer to opt for more profitable but risky projects.
As a matter of fact, it is rather rare to have a direct transfer of resources from subjects in surplus to subjects in deficit. This raises the foundation for the presence of a third party that is able to meet the different needs and to interact by transferring and finally reallocating financial resources within the economic system.
Financial intermediaries realise the channelling of savings into investments. The existence and role of financial intermediaries is explained by the traditional theory that has developed a number of reasons to justify the development of this phenomenon. Among these, we can find the function of evaluating and selecting business projects within the theoretical paradigm of incomplete markets and imperfect information.
This theory puts emphasis on the activities of banks by recognising them as critical due to their ability to solve problems of asymmetric information that are relevant to an imperfect market - adverse selection and moral hazard. Thanks to the role played by financial intermediaries, such problems may be partly solved or at least transferred to the same financial intermediaries that have the means to bear any adverse effects, thus avoiding their transfer onto a single or a small number of savers.
Moral hazard is a risk that can occur in a situation ex-post to the provision of funding and which stems from the misconduct of a company to use loans for riskier assets than those declared. This phenomenon is experienced when a company, once obtained a loan for a specific project with a relative degree of specific risk, is encouraged to use the same resources for riskier targets although with a a higher expected return.
As to the techniques applicable for the resolution of this problem, we can mention the monitoring activities that the bank uses daily with professional and qualified methods. While a bank, which has acquired all the instruments and the professionalism goods with a high fixed cost to conduct a monitoring activity, allocates and redistributes such costs on all projects that are monitored, single economic agents are not in the position of supporting this activity due to the high costs that they should face, such that they would not be able to lend anybody their excess financial resources.
From a theoretical point of view, a model was developed by Diamond who, in the presence of moral hazard, has demonstrated the optimal approach to follow; that is to say, financing investment projects through the activities of an intermediary rather than directly on the market. The first phenomenon is usually experienced prior to the signing of the insurance contract, in case the insurer does not have sufficient information to classify its clients into homogeneous classes of risk, namely in classes that are characterized by the same probability of suffering damage that would lead to establish an equal premium for all those insured against the same risk.
In such cases, the premium would result in being too high for low-risk individuals and too cheap for those expected as the riskiest, thus generating an accumulation of bad risks and the consequent default of the insurance company. The first two types of measures tend to contain the phenomenon of adverse selection, whereas the last three types are most commonly used to limit moral hazard by making observing virtuous behaviours cost-effective for the insured.
Information is therefore essential and the basis of every decision linked to the activities of financial intermediaries. The principal is the one who offers a contract and who is not familiar with the capabilities of the agent to whom the contract is offered. Briefly, in this market, only sellers know the quality of the car on sale while buyers ignore their characteristics.
If the buyers were aware of which car were good, they would pay the price they would feel reasonable for a good car; but since there are also "lemons", they will pay a price that, based on the probability that the car on sale is a lemon, averages between the price reasonable for a bad car and the one judged as appropriate for a good car. Considering the price lower than the correct one, good car sellers would not be inclined to sell, while sales of lemons would be promoted at a higher price than their value.
Considering the trend in sales of lemons, buyers would no longer be inclined to pay the requested price, thereby generating a negative trend in sales, to the point that transactions would decline to zero. This situation generates the need for a third party who acts as an intermediary and has the tools and skills to discharge that function.
Bibliography Cucinotta G. Desiderio Luigi, Molle Giacomo. Di Giorgio G. Guida Roberto. Patroni Griffi and Ricolfi. Quagliariello Mario. Ruozi Roberto. User name Password Remember me Forgot your password?
Forgot your username? Create account. MORAL HAZARD Encyclopedia The role of banking intermediaries is to "intermediate" between players who are in financial deficit and those experiencing a surplus in order to resolve their need to invest available financial resources.
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User name. Remember me. Banks realise their business through a series of different products that are placed and sold on the market producing a system of prices and the tightening of business relationships with plenty of diverse and varied customers. In reviewing different bank models, it is possible to distinguish between specialized banks, universal banks and financial conglomerates. The development of one type rather than another is to be found in the operating efficiency specific to each bank and in the regulatory constraints applied by different countries.
Books by Roberto Ruozi
Economia e gestione della banca