Use two theories of financial intermediation to explain the existence and role of banks
Use two theories of financial intermediation to explain the existence and role of banks, critically discussing and comparing the two theories
Banks have existed in many forms in many countries for many centuries initially involved in basic societal roles as taking and holding deposits for households and providing basic loans to economic agents in need of capital. As traders and merchants started to trade both locally and internationally, for example during the expansion of the different empires, insurance especially marine insurance became much sought after hence the emergency of banks such as Lloyds in England (Allen and Santomero 1997). Banks and other financial intermediaries began to offer such financial services, becoming the main source of external funds to firms. For instance, between 1970 and 1985, financial intermediaries were the main source of more than 50% of external funding in the UK, United States, Japan, Germany, and France (Diamond 1996).
In this essay, we will use two theories, financial intermediation theory and the theory of risk management to explain the existence and role of banks. In doing this, we will critically discuss theories of financial intermediation in the context of transaction costs, information asymmetry, liquidity insurance and other elements of financial intermediation.
1.0 Financial intermediation services
Now days, banks are known for the provision of numerous financial intermediation services such as brokerage services, payment services and asset transformation (Bhattacharya and Thakor 1993). Many have over specialised in the provision of one or more of such services but traditionally, they have often…
Allen, F. and Santomero, A.M. (1997) “The theory of financial intermediation” Journal of Banking and Finance, 21(11), pp. 1461–485
Bhattacharya, S. and Thakor, A.V. (1993) “Contemporary banking theory” Journal of Financial Intermediation, 3(1) pp. 2–50
Diamond, D.W. (1996) “Financial intermediation as delegated monitoring: a simple example” Federal Reserve Bank of Richmond Economic Quarterly, 82(3). pp. 51–66.