Financial Intermediary Capital
This paper proposes a theory of financial intermediaries as collateralization specialists that are better able to collateralize claims than other lenders. Intermediaries require capital as they can borrow against their loans only to the extent that other lenders themselves can collateralize the assets backing the loans. Firms with low net worth borrow from financial intermediaries. Incomplete risk management is optimal for both firms and intermediaries. When the capital of financial intermediaries is limited, it affects the spread between intermediated and direct finance. In a dynamic economy, the capital of the financial intermediary sector is a state variable and affects the dynamics of firm investment, financing, and loan spreads.
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