In the banking literature the existence of financial intermediaries is generally explained in terms of the transformation of risks, terms and lot-sizes. Yet these functions could also be performed by system of perfect and complete markets. Therefore, the approach taken in Why Banks? is to start by investigating the conditions that, in the real world, render markets imperfect and incomplete, namely asymmetric information distribution and uncertainty. Incentive compatible financing instruments (standard debt contracts as well as equity participation) provide a means of solving these problems. Financial intermediaries ultimately owe their existence to their ability to save transaction costs using these instruments and to solve problems relating to the enforcement of contracts.
About the Author
The Author: Ilonka Rühle, born in 1960, studied economics at the University of Frankfurt. After receiving her Ph.D. she became a staff member of the Internationale Projekt Consult (IPC) GmbH. Ms. Rühle played a key role in the establishment of the Russia Small Business Fund, a financial institution building project which IPC is implementing on behalf of the EBRD. She currently serves primarily as a bank adviser in Russia and Eastern Europe, where she has overall responsibility for training loan officers and project personnel.
Table of Contents
Contents: Microeconomic explanation of the existence of financial intermediaries based on informational asymmetries - Adverse selection as a consequence of hidden characteristics, and moral hazard due to unobservable actions or returns, make the establishment of complete and perfect markets impossible - Problems of contract enforceability also call for institutional solutions via banks/financial intermediaries - The same holds true for fundamental uncertainty.