FINM3006

Specialness of financial intermediaries- the two to focus on are information costs and liquidity and price risk.If RBA meets and decides inflation is too high, it's target is 2-3% and they will want to increase the cash rate by reducing money supply via open market operations ( sell bonds in market, get money for selling and chuck it in vault)

Information asymmetry gives rise to moral hazard or agency costs (the idea that lender can't observe what borrower does with money) Flow of funds isn't slowed down because banks can act as delegated monitor on behalf of lenders. 

When a company issues a large amount of securities (such that lender only lends small amount) monitoring costs are not worth it.

FI's role as delegated monitor- As the FI groups these funds together and invests in direct or primary financial claims issued by firms, the large FI has a much greater incentive to collect info and monitor action because it has far more at stake than does any small individual household. The average cost of collecting information is lower.FI's may develop new secondary securities that enable them to monitor more effective e.g. bank loans- the short term nature of which allows the FI to exercise more monitoring power and control over the borrower. In particular, the information the FI generates regarding the firm is frequently updated as its loan renewal decisions are made

Liquidity creation means they take very short term liquid liabilities (very liquid it, deposits with bank we can withdraw any time). The bank transforms these very liquid assets. into very illiquid loans. This gives rise to liquidity risks.This is important because consumers have uncertain consumption needs meaning their consumption path moving forward is unpredictable (liquidity shock). Assets such as real estate or mortgage is not a good hedge for liquidity risk.The ability of a bank to get such an asset and transform it to us is valuable. It allows us to hedge against liquidity risk. Difference in liquidity gives rise to refinancing risk (GFC) a lot of banks rather than financing out of deposits financed out of shorter securities (not eveyrone is going to withdraw their funds at the same time) banks were borrowing from commercial paper markets and finance long term assets which meant there was a continueous need to finance but when info problems arise and you go to re finance and you can't then you have to sell the assets, if you can't sell because no one wants to buy them then it's a vicious cycle

In event of default, equity loses first and then debt holders. The implication of being highly levered is you have very high bankruptcy risk. If everyone wants to withdraw money at the same time then only 5% of deposits will be paid. Add to that the nature of sequential servicing (first in best dressed). If you're an investor in a bank (depositor) and you know the bank is highly levered and not much capital buffer and only holds 5% in cash and serves sequentially, at the first sign of bad news you are going to run to a bank and withdraw money as fast as you can. Can contaminate other banks if they invest in each other to a high degree.

THere are 

The purpose for regulation can be divided into six categories listed on the slide..1. Safety and soundness regulation: diversification, credit exposures and capital adequacy 2. Monetary policy regulation: cash reserves, liquidity3. Credit allocation regulation: lend to socially important sectors4. Consumer protection regulation: product disclosure and codes of conduct

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