4.6Summary

In this chapter we have looked at the activities of nancial institutions which accept

and hold savers’ funds in some form other than deposits. In some cases these

non-deposit-taking nancial intermediaries offer some particular additional service

– insurance is an example – but they all offer a home for people’s savings. The fact

that their liabilities are not deposits obviously distinguishes them from the banks

or monetary nancial institutions that we looked at in the last chapter. A second dis-

tinction is that their inows of funds tend to be much steadier than those of banks

since they are often contractual – savers have made an agreement to make regular

payments on a long-term basis. For some, insurance companies and pension funds

for example, the outows are also more predictable, depending largely upon the

age structure of the population. The fact that these ows are very stable and that

savers are making long-term contracts gives rise to a third distinction between MFIs

and NDTIs. The latter hold long-term assets such as stocks and bonds, whereas the

former’s assets consist of short-term loans to households and rms. Thus, when we

talk about ‘the institutions’ whose decisions are so important in stock and bond

markets, it is these NDTIs that we are referring to rather than banks.

We looked at the total size and distribution of their assets. These assets have been

acquired over many years and enable us to see that these institutions have been

especially important in the funding of rms and government over the years. If we

concentrate on ows of funds within the last few years, the same appears to be

broadly true, but it is always possible for ows in one particular year to be different

from those which have built up the stock of assets, especially if institutions think that

one type of asset is likely to produce better returns than another in the near future.

Questions for discussion

1	Briey summarise the key differences between DTIs and NDTIs.

2	What different things are savers looking for when they hold funds with (a) DTIs and (b) NDTIs?

3	Distinguish between funded and unfunded pension schemes. Would you worry if youwere a member of the latter?

4	When looking at the assets of nancial rms, distinguish between ‘holdings at year end’, ‘net acquisitions’ and ‘turnover’. Which category of gures is always likely to bethe smallest?

5	Suppose that mortality rates suddenly became less predictable. How would you expect that to affect long-term insurance companies’ choice of assets?

6	Explain how insurance companies try to deal with the problems of moral hazard and adverse selection.

7	Why do shares in closed-ended mutual funds often sell for less than the value of their underlying assets?

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Chapter 4 • Non-deposit-taking institutions

Further reading

M Buckle and J Thompson, The UK Financial System(Manchester: Manchester UP, 4e, 2004)

chs. 6 and 16

E Philip Davis, Institutional Investors(Cambridge MA: MIT Press)

R Glenn Hubbard, Money, the Financial System and the Economy (Reading MA: Addison-

Wesley, 2e, 1997) chs. 12–14

PGA Howells and K Bain, The Economics of Money, Banking and Finance(Harlow: Financial

Times Prentice Hall, 3e, 2005) chs. 15 and 16

EH Neave, Financial Systems: Principles and Organisation (London: Routledge, 1997)

K Pilbeam, Finance and Financial Markets (London: Macmillan, 1998)

‘Sandler Report’ (2002) at www.hm-treasury.gov.uk/documents/nancial_services/savings/

n_sav_sand.cfm

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CHAPTER5

The money markets

Objectives

What you will learn in this chapter:

lWho uses the money markets and for what purpose

lWhat the various money markets are

lHow different money market instruments are priced

lWhy ‘money market operations’ are important to central banks

lHow to read, interpret and analyse data relating to the money market

In Chapters 3 and 4 we have been looking at the major groups of institutions that

participate in the nancial system. In this chapter, and in Chapters 6, 8 and 9, we

shall look at the markets in which these institutions operate. Financial institutions

are not the only participants, of course. All nancial markets (not just the money

markets) involve brokers, market-makers, speculators, as well as the ultimate borrowers

and lenders – rms, governments and occasionally households. Box 5.1 provides a

list of the major market participants and their functions. The box makes it clear why

nancial markets tend to be dominated by institutions (DTIs and NDTIs) rather than

individuals.

It is common to talk of two groups of domestic nancial markets: the money

markets and the capital markets. In one sense this is misleading. In both markets

what is offered for sale is debts or claims, in exchange for money. In both markets

it is money that is being borrowed. The difference which justies the labels is the

period to maturity of the debts or, more simply, the length of time for which the

funds are borrowed. In the money markets, funds are borrowed for a short period,

i.e. less than one year; in the capital markets, funds are borrowed for long-term use,

in some cases indeed with no promise of ever being repaid. Although the distinction

is useful and well recognised, it does not of course constrain people’s behaviour. Some

institutions – banks and building societies, for example – are accustomed to working

in money markets, while others, like pension funds, are accustomed to capital markets,

but these boundaries are occasionally crossed when commercial circumstances require.

Certainly, ultimate borrowers and lenders are free to switch as the advantage of doing

so presents itself. Firms may, as a rule, prefer to raise capital by issuing long-term bonds,

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Chapter 5 • The money markets

Box 5.1

Market participants

Ultimate lenders and borrowers

Ultimate lenders are households and rms with a nancial surplus which they want to

lend, while ultimate borrowers are rms and governments with a nancial decit which

need to borrow. It is not usual for ultimate lenders and borrowers to participate in markets

directly. As a rule they deal through an intermediary which performs one or other of the

following functions.

Broker

Strictly speaking a broker is someone who brings together two parties with a coincidence

of wants. In practice, however, brokers tend to act as agents of lenders or buyers of

a nancial service. Thus, they may undertake to nd the best price for someone who

wishes to buy or sell securities or to nd the best insurance policy, for example.