Chapter 4
Financial
Intermediaries
1
The Direct Transfer
A.New Securities
1.Sale facilitated by investment bankers
2.Funds are directly transferred from
savers to firms
Savers have claims (debt or equity)
on issuer.
Issuer receives the money.
2
The Indirect Transfer through a
Financial Intermediary
B. Financial Intermediary
1.Savers deposit funds in a bank, that
individual receives a claim on the bank (the
account) and not on the firm to whom the
bank lends the funds
2.If the intermediary makes a bad loan, the
saver does not sustain the loss unless the
financial intermediary fails
3
The Indirect Transfer through a
Financial Intermediary
 Savers have claims on the financial
intermediary.
 Financial intermediaries have claims on
ultimate user of the funds.
 Each financial intermediary creates claims on
itself and transfers funds from savers to:
– Firms
– Governments
– People who need funds
4
Variety of Financial Intermediaries
C. Types of Intermediaries
– Commercial Banks
– Thrift Institutions
• Savings and Loan Associations
• Mutual Savings Banks
• Credit Unions
– Life Insurance Companies
– Pension plans
– Money market mutual funds
5
Financial Intermediaries Regulation
D. Depository Institutions Deregulation
and Monetary Control Act of 1980
1.All depository institutions are subject to
regulation by the Federal Reserve
2.Gave managements of various financial
institutions more flexible to vary their
loan portfolios
3.Depository institutions are able to
borrow funds from the Federal Reserve
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Commercial Banks
Assets and liabilities
– Importance of loans
– Importance of deposit liabilities
– Small equity base
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Commercial Banks
A. Commercial Banks are the most
important depository institution
B. Primary assets are consumer loans
1. Stress that loans must be paid off quickly
2. Because of rapid bank deposit turnover
C. Primary liabilities are deposits
1. Checking accounts (demand deposits)
2. Savings accounts
3. Time deposits
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Variety of Deposits
D. Demand Deposits are payable on demand
1. The owner of a checking account/savings
account can demand immediate cash
E.
Certificates of Deposit (CD)
1. Time Deposits
2. Fixed Term
a) May redeem earlier but will pay penalty
3. Bank established the terms (interest rate and
time)
4. Terms offered by one bank are similar to
other banks
a) Call and find the best rate and time
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Variety of Deposits
F. Negotiable CD
1. Certificate of deposit issued in
amounts of $100,000 or more whose
terms are individually negotiated
between the bank and the saver
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Variety of Deposits
F. Negotiable CD
1. Certificate of deposit issued in
amounts of $100,000 or more whose
terms are individually negotiated
between the bank and the saver
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Thrift Institutions
A. Place for savers
B. The money that is in savings accounts is
loaned by the thrift to borrowers in need of
funds
C. Two Types
1. Mutual Savings Bank
a) Owned by its depositors
b) Bank is managed by board of directors
2. Savings and Loan Association
a) Primarily a source of mortgage loans
b) Has evolved into a thrift institution that accepts deposits from
anyone and makes a variety of loans
c) Slightly higher interest rates
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Regulation of Depository Institutions
A. Government Regulation
1. Protect the banks creditors
a) Depositors
B. Federal Deposit Insurance
Corporation (FDIC)
1. $250,000 per person (social security
number)
2. All commercial banks that are part of
the Federal Reserve System must
purchase this insurance
3.Adds stability to the banking system.
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Regulation of Depository Institutions
Reserves
C. Required Reserves
1. Commercial banks and other depository
institutions must keep funds in reserve
against their deposit liabilities
D. Determined by the Federal Reserve
E. Controls money supply
F. Commercial banks and holding
reserves:
1. Cash in the vault
2. Deposits with another bank
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Regulation of Depository Institutions
Reserves
E.
Excess Reserves
1. Reserves held by a bank in excess of those it
must hold to meet its reserve requirement
2. Excess may be loaned out
3. No excess-“Fully Loaned Up”
F.
Correspondent Bank
1. Major bank with which a smaller bank has a
relationship to facilitate check clearing and to
serve as a depository for reserves
G. Secondary Reserves
1. Short-term securities held by banks to increase
liquidity
a) Treasury Bills
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Regulation of Depository Institutions
Deposit Insurance
H. Federal government deposit insurance resulted
from the Great Depression of the 1930’s.
I. Federal Deposit Insurance Corporation (FDIC)
1.
2.
3.
4.
Increased the public’s confidence in the banking system.
Protect the banks creditors (Depositors)
Insures deposits up to $250,000 per person (SS #).
Has powers of bank examination.
J. All commercial banks that are members of the
Federal Reserve System must purchase insurance
from FDIC
K. Many state banking authorities also require that
FDIC insurance be carried
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Life Insurance Companies
A. Insure an individual from death
B. Long Term
C. Life insurance or life assurance is a contract between
the policy owner and the insurer, where the insurer
agrees to pay a sum of money upon the occurrence of
the insured individual's or individuals' death or other
event, such as terminal illness or critical illness. In
return, the policy owner agrees to pay a stipulated
amount called a premium at regular intervals or in lump
sums. There may be designs in some countries where
bills and death expenses plus catering for after funeral
expenses should be included in Policy Premium.
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Pension Plans
A. Accumulate assets for workers so they will have
funds for retirement
B. Funds are periodically put into the pension plan by the
saver, employer, or both
C. Used to purchase income-earning assets
D. In general, a pension is an arrangement to provide
people with an income when they are no longer earning
a regular income from employment. It is a tax deferred
savings vehicle that allows for the tax-free
accumulation of a fund for later use as a retirement
income. Pensions should not be confused with
severance packages; the former is paid in regular
installments, while the latter is paid in one lump sum. 18
Money Market Mutual Funds
Specialized investment company
Makes only short-term investments
Acquires money market instruments
Shares in money funds have become
popular investments
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Money Market Mutual Funds
A. Invests on the behalf of individuals
B. Is a mutual fund a financial intermediary?
1. Yes, if the fund transfers the invested money
to a firm, government, or individual seeking to
borrow funds
2. No, if the fund buys securities on the
secondary market. The money is transferred
to another investor who is seeking to liquidate
a position in the particular security
3. Most mutual funds do not serve as a financial
intermediary because they buy existing
securities
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Money Market Mutual Funds
C.
Money Market Mutual Fund
1. Investment Company that invests solely in newly
issued short-term money market instruments
2. Held until maturity, at which time the process is
repeated
3. Why are Money Market Mutual Funds Popular?
a) Safety of principal
(1) Short-term (2) Minimal price fluctuations
(3)Minimal risk of default because of high credit ratings
b) Liquidity
(1) Individuals may withdrawal money at will
c) High interest rates
(1) Fund offers competitive short-term yields
(2) Mostly higher than commercial banks
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Money Market Instruments
4. Money Funds Invest in a Variety of
Short-Term Securities
a) Negotiable CD
b) US Treasury Bill (T-Bill)
(1) Short-term debt instrument issued by the federal
government
(2) Maturity of less than one year
c) Commercial Paper
(1) Unsecured short-term promissory notes issued by the
most creditworthy corporations
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Money Market Instruments
a) Repurchase Agreement (Repo)
(1) Sales of a short-term security in which the seller agrees
to buy back the security at a specified price
b) Banker’s Acceptance
(1) Short-term promissory note guaranteed by a bank
c) Tax Anticipation Notes
(1) Short-term government security secured by expected
tax revenues
d) Eurodollar CD
(1) Issued by either branches of domestic banks located
abroad or by foreign banks
(2) Denominated in US Dollars
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Money Market Instruments
5. Money Funds usually invest in a wide
variety of investments, some of the
funds do specialize
a) Government securities
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Competition of Funds
A. A commercial bank or any financial intermediary
can lend only what has been lent to it
B. No one can make investment without a source of
funds
C. A transfer of funds from one intermediary to
another can have an important impact on the
supply of credit available to a particular sector of
the economy
D. Although the total supply of credit is unaffected,
there will be a redistribution of credit
E. Financial intermediaries compete with each other
for funds
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