Essay on Current Theories Of Financial Intermediaries

968 Words Apr 12th, 2015 4 Pages
Current theories of the role of financial intermediaries are built on the failure in the financial market. Five the main theories explain why financial intermediaries exist: Delegated monitoring, information production, liquidity transformation, consumption smoothing and commitment mechanisms. One of these five main theories concerns the ability of financial intermediaries in producing information.
The expression “asymmetric information” refers to the imperfect distribution of the information. Indeed, it describes a situation in which one party in a transaction has more or better information compared to the other party. For instance, when the sellers know more than the buyers, we can indeed speak about asymmetric information. The information is key to all financial transaction and this is why asymmetric information makes transaction more difficult. Asymmetric information lead to two main issues: adverse selection (ex ante) and moral hazard (ex post). In other words, the lack of information creates troubles before and after the loan. Financial intermediaries use their size and expertise to remedy to this market failure.
The major explanation of why people invest or lend money through the process of financial intermediation is due to the risk that is present from the information asymmetry. In the case of adverse selection, sellers may know more about the quality of the product than the buyers. This type of information asymmetry occurs before the transaction has taken place.…

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