A central function of the financial system is to facilitate an efficient allocation of resources in the economy... Discuss.
must be investigated and will therefore lead on to the final enforcement cost. This cost will be implemented in order to claim compensation if any contract is breached (Heffernan, S, p18-19).
One incentive highlighted is the banks ability to reduce risk via diversifying their portfolio, similar to other intermediaries which will be spoke about later. Banks improve terms facing borrowers by ‘transforming maturities and providing liquid liabilities which meet the needs of savers whilst employing their funds in longer term financial instruments which are more convenient to borrowers’ (Bain, p.11). Banks can do this as they can rely on a degree of stability in their deposit-base. They transfer risk by diversifying their holdings that is spreading over a wide range of securities to reduce lost. Banks, building societies, unit trusts and a large number of financial institutions have relatively small financial surpluses or deficits yet issue a large volume of financial claims.
Another type of financial intermediary is the concept of the market. A market is the organised apparatus of dealers and brokers acting as intermediaries. Financial markets represent forums that facilitate the low of funds between investors, firms and government unit and agencies. There are two types of markets which make up the financial sector; primary markets allow new financial claims to be floated, thus generating new money, previously issued claims are traded on secondary markets, where no new money is created, allowing wealthy investors to change their portfolios of assets and liabilities (the volume of transactions in the UK is greater in the secondary market than in the primary so is no good for industry), i.e.; allowing greater ease of re-allocating resources if preferences change.
Organised markets ‘provide the facilities for economic agents to lend, borrow, buy/sell securities’ (Bain, p.5). Examples of organised markets include the stock exchange, foreign exchange (entirely, international), money markets and capital markets. The stock exchange is a market with a trading floor, on which all deals are conducted between brokers and dealers. In a closed exchange, all transactions take place with the exchange itself. Intermediaries play a big role in open exchanges- brokers bring buyers and sellers together; market makers (dealers) act as principles, buying and selling claims which they would hold themselves in order to make a profit. The role of a broker or adviser is to provide information to the people involved in the markets and to ensure they have sufficient facts to strike a fair deal. With this trading, new businesses can raise capital for expansion etc, thus again providing another area in which to allocating investors funds will help develop a stronger economy.
Another type of financial institution which exists in again the form of an intermediary is the area of insurance. Insurance companies are intermediaries whose first function is to provide households and business’s to discard risks by buying contracts called insurance policies that pay cash compensation or replace certain goods in the even of specific events taking place. Insurance companies offer various types of insurance for their customers, including property and liability [next page]