1.3 Lenders and borrowers

Finally, before leaving this discussion of saving and lending, notice that we some-

times need to distinguish between ‘net’ and ‘gross’ lending. We have said that a

nancial surplus is what people have available to lend. However, people may appear

to lend in excess of that surplus. This arises because in any period of time people

may be both borrowers and lenders. For example, under tax rules at the time of

writing a home-owner with no mortgage may nd it protable not just to lend his

or her current nancial surplus but to take out a mortgage on the house and to lend

the borrowed funds. More importantly, when we come to consider the behaviour

of groups of agents, for example the personal sector, we shall nd that the aggregate

surplus is the difference between a much larger total of individual surpluses and

a large number of individual decits. The amount of ‘gross’ lending that takes place,

therefore, is very much greater than the ‘net’ lending which must be equal to the

nancial surplus.

1.3.2Borrowing

At the same time as some people have income which they do not wish to spend

entirely upon current consumption, there will be those rms, people and public

authorities whose expenditure plans exceed their income. These plans can be realised

only if their owners either draw on past savings or engage in borrowing. The plans

may be to spend on ‘real’ assets. These in turn may be of two types: ‘investment’ or

‘capital’ goods as bought by rms to assist in producing more goods; or consumer

goods, usually of the ‘durable’ kind whose initial cost is high in relation to income

but which will provide a ow of benets over several years. In certain circumstances,

however, one can envisage people borrowing in order to acquire ‘nancial’ assets.

This would occur in situations such as the initial sale of BP shares in 1987 where

people thought that the gains from acquiring the asset would be greater than the

cost of the liability (the debt into which they were entering) by borrowing to buy

the shares.

The interests of borrowers are mainly twofold. Firstly, they will wish to minimise

cost. The cost to the borrower is the yield to the lender and may take any of the

forms which we have just been discussing.* It is worth noting, however, that while

as a general rule borrowers will obviously be looking to borrow in the cheapest

way, they may have preferences about the way in which they meet this cost and

therefore about the sort of liabilities they incur. For example, a young rm engaged

in rapid expansion may well decide to issue shares. In the early stages, dividend

payments may be very small because prots have yet to come through, but share-

holders will be rewarded by seeing the capital value of their shares rising with the

growth of the company. However, raising the nance by borrowing, either from a

* If the loan comes from an intermediary, the cost to the borrower will be the interest rate

charged by the intermediary, which will be the yield to the lender plusthe mark-up added by

the intermediary.

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Chapter 1

• Introduction: the nancial system Table 1.3The objectives of lenders and borrowers LendersBorrowers

Return (to lender)	
Risk
Transaction costs
Liquidity	

bank or by issuing xed-interest bonds, will mean paying interest on the loan from

the outset. This cash drain could be critical in the early stages of expansion.

By contrast with lenders, borrowers will wish to maximise the periodfor which

they have use of the loan. This has two benets. It reduces the risk that the lender

will have to be repaid at a time which is inconvenient to the borrower and also

reduces the exposure of the borrower to the risk that funds might become short or

very expensive in the future. Like lenders, borrowers will also wish to minimise the

(transaction) costs of setting up the deal.

These contrasting interests of lenders and borrowers are summarised in Table 1.3.

The signs in brackets indicate whether the lender/borrower is seeking to maximise

(+) or minimise (–) the characteristic.