Why do financial intermediaries exist

1
Introduction
2
Why do financial intermediaries exist?

• Transaction Costs
• Asymmetric Information

3
Transaction Costs

• Financial Intermediaries Reduce Transaction Costs
• Economies of Scale
• Expertise

4
Asymmetric Information

• Asymmetric Information
• Adverse Selection (occurs before the transaction
  occurs)
• Moral Hazard (arises after the transaction occurs)

5
Asymmetric Information

• The Lemons Problem (Akerlof (1970))
• Used-car market analogy
• Lemons in the stock and bond markets

6
Asymmetric Information

• Tools to solve adverse selection problems
• Private production and sale of information
• Free-rider problem
• Government regulation
• Financial Intermediation
• Collateral and net worth

7
Asymmetric Information

• Moral Hazard in Equity Contracts
• The Principal-agent Problem

8
Asymmetric Information

• Tools to solve the Principal-Agent problem
• Production of information Monitoring
• Government regulation to increase information
• Financial intermediation
• Debt contracts

9
Asymmetric Information

• Moral Hazard in Debt Markets
• Tools to solve the Moral Hazard in debt
  contracts
• Net Worth
• Monitoring and enforcement of restrictive
  covenants
• Financial intermediation