Banking: Why Are Financial Institutions Special?

Chapter 1 – Why are Financial Institutions (FI) special? * information costs: the aggregation of funds in a FI provides greater incentive to collect information about customers and to monitor their actions. The relatively large size of the FI allows this collection of information to be accomplished at a lower average cost (economies of scale) than would be the case for individuals * liquidity and price risk: FIs provide financial claims to household savers with superior liquidity attributes and with lower price risk * transaction cost services: similar to economies of scale in information production costs, a FI’s size can result in economies of scale in transaction costs * maturity intermediation: FIs can better bear the risk of mismatching the maturities of their assets and liabilities * transmission of monetary supply: depository institutions are the conduit through which monetary policy actions by the country’s central bank impact the rest of the financial system and the economy * credit allocation: FIs are often viewed as the major, and sometimes only, source of financing for particular sectors of the economy, such as farming, small business, residential real estate * intergenerational wealth transfers: FIs, especially life insurance companies and pension funds, provide savers with the ability to transfer wealth from one generation to the next * payment services: the efficiency with which depository institutions provide payment services such as check clearing directly benefits the economy * denomination intermediation: FIs, such as mutual funds, allow small investors to overcome constraints to buying assets imposed by large minimum denomination size
Glass-Steagall Act (1933) sought to separate commercial banking from investment banking, by limiting the powers of commercial banks to engage in securities activities * commercial banking: banking activities of deposit taking and lending * investment banking: banking