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Summary Lectures Bank Management W. Boonstra
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Summary Lectures Bank Management W. Boonstra (2018/2019)
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Bank ManagementLectures W. Boonstra
1. Introduction and functions of a financial system. Book chapters 16-18
What are the functions of a financial system?
A financial system should facilitate an efficient allocation of financial resources.
6 major tasks:
1. It should facilitate financial transactions between agents in a country via a payment
system (bank account, cash, interaction between the two)
2. It should enable the pooling of funds
3. It should be able to allocate the available funds to the most efficient users
4. It should enable economic agents to mitigate and or manage risk
5. It should generate information by the production of prices, which is essential for the
proper functioning of a market economy.
→ a properly working price mechanism is essential for the functioning of a market
economy!
6. Reduction of information asymmetries.
Surplus and Deficit Households
Surplus households (savers or investors):
1. Households with a positive savings ratio and/or a large net wealth
2. Older folks that save for their retirement
3. Companies with surplus cash flows
4. Governments with budget surpluses
Deficit households:
1. Families that want to borrow to buy a house
2. Companies with negative cashflow (i.e. due to large investment outlays)
Note: this has nothing to do with poverty versus wealth
The most important agents
1
,Financing the economy → Direct versus indirect financing:
Direct financing:
A direct cashflow from surplus households to deficit households.
1. Companies borrow directly from investors or savers
2. Crowd funding
3. Families that need money borrow money from other families with surplus money
4. Companies directly lend money to/borrow from each other (credit unions)
5. Investors buying bonds or shares from companies
Deficit Households Loan or investment Surplus Households
Deficit Households → Interest, dividend and repayment → Surplus Households
Examples:
• Direct lending
• Direct investment
Advantages Direct Finance:
1. Direct flow from savers to borrowers:
no extra margin necessary
2. Direct relation between
savers/investors and deficit households
Disadvantages Direct Finance:
1. No transformation of risk
2. Surplus households run credit risk
3. Liquidity risk for both parties if preferences diverge
4. Concentration risk, especially for small savings portfolios
5. Information overload
Indirect financing:
An indirect cashflow from surplus households to deficit households (using intermediaries).
1. Surplus households hold their savings at a bank, the bank lends to deficit households
2. Investors buy shares in an investment fund, the investment fund buys shares or
bond issued by companies
Advantages Indirect Finance:
1. Transformation of risk (liquidity and credit)
2. Transformation of size
3. Economies of scale and scope
Disadvantages Indirect Finance:
1. Surplus households receive a lower interest than what the borrower pays
2. The difference is income for the intermediary (fees, interest margins)
2
, When indirect financing via banks → risk concentrates at the bank
Indirect finance: Banks versus Other intermediaries
Banks
Advantages: Disadvantages:
1. Savings are very liquid 1. Low yield
2. No price risk 2. Non-transparent
3. No liquidity risk for surplus 3. Credit risk for the bank
households
4. No credit risk for surplus households
5. Deposit guarantee
Investment Funds
Advantages: Disadvantages
1. Potentially higher yield 1. Credit risk remains with surplus
households
2. Price risk
Note: intermediaries can also play a role in direct finance. In example, credit unions or
crowd funding.
Money: Definition and Functions
Money is anything that, within a certain community, is generally accepted as medium of
exchange, unit of account or store of value.
The use of money: (money promotes efficiency)
• Reduces search costs
• Promotes specialization and division of labor
• Reduces the number of necessary transactions
• Reduces the number of prices/makes it easier to compare value of things
Without money: n(n-1)/2 prices. With money: (n-1) prices.
3
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