Lecture on Financial Intermediation and Economic Impact

Introduction

• Financial intermediaries play a crucial role in modern economies.
  • They connect savers with borrowers.
  • Their failure leads to economic hardships, similar to the impact of physical bridge failures.

Importance of Financial Intermediaries

• Businesses often rely on credit to operate and grow.
  • Lack of credit can lead to bankruptcies and layoffs.
• Individuals need credit for education, housing, and essential repairs.
  • Without credit, personal growth and economic stability are hampered.

Challenges in Economically Underdeveloped Countries

• Many poorer nations lack access to safe, affordable financial systems.
• The absence of financial intermediation results in reduced economic growth.

Reasons for Failure of Financial Intermediation

1. Insecure Property Rights

   • Examples include government interventions in Cyprus (2013), Argentina, Brazil, and Russia.
   • These actions scare away savings, leading to intermediation failure.

2. Controls on Interest Rates (Usury Laws)

   • Usury laws create a price ceiling on interest rates.
   • These often lead to shortages of funds and reduced lending quantity.

3. Politicized Lending

   • Government involvement can result in loans based on political connections rather than economic merit.
   • Japan's 'zombie banks' phenomenon due to government support for insolvent banks.
   • Negative impact seen with increased government ownership of banks.

4. Runs, Panics, and Scandals

   • Trust is essential; fractional reserves mean banks cannot meet all withdrawal demands simultaneously.
   • Historical instances include bank runs during the American Great Depression.
   • Scandals (Enron, WorldCom) undermine investor trust, scaring investment away.

Historical Context and Examples

• Japan's Lost Decade (1990-2000)

  • Economic stagnation partly due to failure of financial intermediaries.
  • Government support for insolvent banks led to impaired economic competition.

• US Great Depression

  • Bank runs led to widespread bank failures.
  • Creation of the FDIC to ensure depositor trust and stability.

Conclusion

• Understanding the causes of financial intermediation failure is crucial for economic development.
• The next discussion will cover the Great Recession of 2008 and its relation to these failures.