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See discussions, stats, and author profiles for this publication at: https://www.researchgate.net/publication/23739309Financial Intermediation
Article · January 2002
Source: RePEc
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2 authors:
Gary Gorton Andrew Winton
Yale University University of Minnesota Twin Cities
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, NBER WORKING PAPER SERIES
FINANCIAL INTERMEDIATION
Gary Gorton
Andrew Winton
Working Paper 8928
http://www.nber.org/papers/w8928
NATIONAL BUREAU OF ECONOMIC RESEARCH
1050 Massachusetts Avenue
Cambridge, MA 02138
May 2002
Forthcoming in Handbook of the Economics of Finance, edited by George Constantinides, Milt Harris and
Rene Stulz (Amsterdam: North Holland). The views expressed herein are those of the author and not
necessarily those of the National Bureau of Economic Research.
© 2002 by Gary Gorton and Andrew Winton. All rights reserved. Short sections of text, not to exceed two
paragraphs, may be quoted without explicit permission provided that full credit, including © notice, is given
to the source.
,Financial Intermediation
Gary Gorton and Andrew Winton
NBER Working Paper No. 8928
May 2002
JEL No. G0, G2
ABSTRACT
The savings/investment process in capitalist economies is organized around financial
intermediation, making them a central institution of economic growth. Financial intermediaries are firms
that borrow from consumer/savers and lend to companies that need resources for investment. In contrast,
in capital markets investors contract directly with firms, creating marketable securities. The prices of
these securities are observable, while financial intermediaries are opaque. Why do financial
intermediaries exist? What are their roles? Are they inherently unstable? Must the government regulate
them? Why is financial intermediation so pervasive? How is it changing? In this paper we survey the
last fifteen years’ of theoretical and empirical research on financial intermediation. We focus on the role
of bank-like intermediaries in the savings-investment process. We also investigate the literature on bank
instability and the role of the government.
Gary Gorton Andrew Winton
The Wharton School Carlson School of Management
University of Pennsylvania University of Minnesota
Philadelphia, PA 19104-6367
and NBER
gorton@wharton.upenn.edu
, 1
I. Introduction
Financial intermediation is a pervasive feature of all of the world’s economies. But, as Franklin
Allen (2001) observed in his AFA Presidential Address, there is a widespread view that financial
intermediaries can be ignored because they have no real effects. They are a veil. They do not affect asset
prices or the allocation of resources. As evidence of this view, Allen pointed out that the millennium
issue of the Journal of Finance contained surveys of asset pricing, continuous time finance, and corporate
finance, but did not survey financial intermediation. Here we take the view that the savings-investment
process, the workings of capital markets, corporate finance decisions, and consumer portfolio choices
cannot be understood without studying financial intermediaries.
Why are financial intermediaries important? One reason is that the overwhelming proportion of
every dollar financed externally comes from banks. Table 1, from Mayer (1990), is based on national
flow-of-funds data. The numbers are percentages, so in the United States for example, 24.4% of firm
investment was financed with bank loans during the 1970 - 1985 period. Bank loans are the predominant
source of external funding in all the countries. In none of the countries are capital markets a significant
source of financing. Equity markets are insignificant. In other words, if finance department staffing
reflected how firms actually finance themselves, roughly 25 percent of the faculty would be researchers in
financial intermediation and the rest would study internal capital markets.
As the main source of external funding, banks play important roles in corporate governance,
especially during periods of firm distress and bankruptcy. The idea that banks “monitor” firms is one of
the central explanations for the role of bank loans in corporate finance. Bank loan covenants can act as
trip wires signaling to the bank that it can and should intervene into the affairs of the firm. Unlike bonds,
bank loans tend not to be dispersed across many investors. This facilitates intervention and renegotiation
of capital structures. Bankers are often on company boards of directors. Banks are also important in
producing liquidity by, for example, backing commercial paper with loan commitments or standby letters
of credit.
Consumers use bank demand deposits as a medium of exchange, that is, writing checks, using
credit cards, holding savings accounts, visiting automatic teller machines, and so on. Demand deposits
are securities with special features. They can be denominated in any amount; they can be put to the bank
at par (i.e., redeemed at face value) in exchange for currency. These features allow demand deposits to
act as a medium of exchange. But, the banking system must then “clear” these obligations. Clearing
links the activities of banks in clearinghouses. In addition, the fact that consumers can withdraw their
funds at any time has, led to banking panics in some countries, historically, and in many countries more
recently.
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