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What Do Financial Intermediaries Do?

Author

Listed:
  • Franklin Allen
  • Anthony M. Santomero

Abstract

This paper presents evidence that the traditional banking business of accepting deposits and making loans has declined significantly in the US in recent years. There has been a switch from directly held assets to pension funds and mutual funds. However, banks have maintained their position relative to GDP by innovating and switching from their traditional business to fee-producing activities. A comparison of investor portfolios across countries shows that households in the US and UK bear considerably more risk from their investments than counterparts in Japan, France and Germany. It is argued that in these latter countries intermediaries can manage risk by holding liquid reserves and intertemporally smoothing. However, in the US and UK competition from financial markets prevents this and risk management must be accomplished using derivatives and other similar techniques. The decline in the traditional banking business and the financial innovation undertaken by banks in the US is interpreted as a response to the competition from markets and the decline of intertemporal smoothing.

Suggested Citation

  • Franklin Allen & Anthony M. Santomero, 1999. "What Do Financial Intermediaries Do?," Center for Financial Institutions Working Papers 99-30, Wharton School Center for Financial Institutions, University of Pennsylvania.
  • Handle: RePEc:wop:pennin:99-30
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    File URL: http://fic.wharton.upenn.edu/fic/papers/99/9930.pdf
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    References listed on IDEAS

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    More about this item

    Keywords

    Intermediation; Risk management; Delegated monitoring; Banks; Participation costs;
    All these keywords.

    JEL classification:

    • G2 - Financial Economics - - Financial Institutions and Services
    • G1 - Financial Economics - - General Financial Markets
    • E5 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit
    • L2 - Industrial Organization - - Firm Objectives, Organization, and Behavior

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