1. Why do you think financial intermediarie exist?

2. What roles do they have in the economy?

TEXT B

Most people do not enter financial markets directly but use intermediaries or middlemen. Commercial banks are the financial intermediary we meet most often in macroeconomics, but mutual funds, pension funds, credit unions, savings and loan associations, and to some extent insurance companies are also important financial intermediaries. When people deposit money in a bank, the bank uses the funds to make loans to home buyers for mortgages, to students so they can pay for their education, to business to finance inventories, and to anyone else who needs to borrow. A person who has extra money could, of course, seek out borrowers himself and bypass the intermediary. By eliminating the middleman, the saver could get a higher return. Why, then, do so many people use financial intermediaries?

Financial intermediaries provide two important advantages to savers. First, lending through an intermediary is usually less risky than lending directly. The major reason for reduced risk is that a financial intermediary can diversify. It makes a great many loans, and even though some of those loans will be mistakes, the losses will be largely offset by loans that are sound. In contrast, an average saver could directly make only a few loans, and any bad loans would substantially affect his wealth. Because an intermediary can put its "eggs" in many "baskets," it insures its depositors from substantial losses.

Another reason financial intermediaries reduce risk is that by making many loans, they learn how to better predict which of the people who want to borrow money will be able to repay. Someone who does not specialize in this lending may be a poor judge of which loans are worth making and which are not, though even a specialist will make some mistakes.

A second advantage financial intermediaries give savers is liquidity. Liquidity is the ability to convert assets into a spendable form – money – quickly. A house is an illiquid asset; selling one can take a great deal of time. If an individual saver has lent money directly to another person, the loan can also be an illiquid asset. If the lender suddenly needs cash, he must either persuade the borrower to repay quickly, which may not be possible, or he must find someone else who will buy the loan from him, which may be very difficult. Although the intermediary may use its funds to make illiquid loans, its size allows it to hold some funds idle as cash to provide liquidity to individual depositors. Only when a great many depositors want to withdraw deposits at the same time, which happens when there is a "run" on the institution, will the financial intermediary be unable to provide liquidity. Unless it can obtain help from the government or other institutions, it will be forced to suspend payments to depositors.

Economists are concerned that financial intermediaries can be a source of shocks to the economy, bumps that can disrupt the normal flow of economic life. This concern arises for at least two reasons. First, bank debt serves as money, so disruptions to banks can affect the amount of money in circulation. Second, financial intermediaries are tied together through chains of debts and assets. Because of these linkages, the failure of one financial intermediary can weaken others, increasing their chances of failure. As a result, there is the possibility that if a key financial intermediary fails, that failure can create a domino effect that could cause other financial institutions to fail, ultimately causing the financial sector to "seize up" and stop functioning. Serious disruption of the financial markets will disrupt the rest of the economy.

Ex.1. Find in the text sentences containing the following words and word combinations and translate them into Ukrainian.

To deposit money in a bank; to make loans to home buyers for mortgages; to finance inventories; extra money; bypass the intermediary; get a higher return; to offset losses by loans that are sound; to reduce risk; to insure depositors from substantial losses; to to hold some funds idle as cash; convert assets into a spendable form; to withdraw deposits; to provide liquidity; to suspend payments to depositors; to disrupt the normal flow of economic life; to be tied together through chains of debts and assets.

Ex.2. Understanding details

Mark the sentences T (true) or F (false) according to the information in the text. Find and read out the part of the text, which gives the correct information.

1. Most people enter financial markets directly because it is too expensive to use intermediaries or middlemen.

2. When an individual makes direct investment he or she can get greater profits.

3. Investments made through intermediaries are less risky because they invest in well-known companies.

4. People who do not have expertise in lending can hardly predict the behaviour of would-be borrowers.

5. Intermediaries usually provide high liquidity of investments.

6. The failure of a key financial intermediary is unlikely to have any impact on the functioning of the rest of the economy.

Ex.3 Answer the following questions in your own words.

1. What financial institutions may act as financial intermediaries?

2. Why do individuals and businesses use the services provided by financial intermediaries?

3. What are the advantages of the existence of financial intermediaries for the savers?

4. Why is lending through an intermediary usually less risky than lending directly?

5. What does the term liquidity mean? Why are investments made through financial intermediaries usualy liquid?

6. What are the reasons that financial intermediaries can be a source of shocks to the economy?

Ex.4. Study the terms given below then read the passage and answer the following questions: (1) Why do financial intermediaries exist? and (2) What accounts for international financial intermediation?

Asymmetric information – the situation in which one party to an economic transaction has better information than does the other party.

Adverse selection – The problem investors experience in distinguishing low-risk borrowers from high-risk borrowers before making an investment; in insurance, the problem that those most likely to buy insurance are also most likely to file claims.

Moral hazard – the risk that people will take actions after they have entered into a transaction that will make the other party worse off; in financial markets, the problem investors experience in verifying that borrowers are using their funds as intended.

Economies of scale – the reduction in average cost that results from an increase in the volume of a good or service produced.

A key reason that financial intermediaries exist is to address problems arising from asymmetric information. One such problem is adverse selection, or the potential for the least creditworthy borrowers to be the most likely to seek to issue financial instruments. Another is moral hazard, or the possibility that an initially creditworthy borrower may undertake actions that reduce its creditworthiness after receiving funds from a lender. A further reason for the existence of financial intermediaries is the existence of economies of scale, or the ability to spread costs of managing funds across large numbers of savers. A potential justification for international financial intermediation by global banking enterprises is that they may experience economies of scale in information processing by spreading their credit evaluation and monitoring operations across the world.

Ex.5. Study the text balow and explain in English the meanings of the underlined words and word combinations.

Role of Financial Intermediaries

The financial system is a key factor when it comes to explaining and understanding the development of the world’s economy throughout the years. The creation of money as a means of exchange and the increasing need of people to find an efficient and beneficial way to trade their assets, and more importantly to take advantage of the great monetary value attached to them has caused the appearance of specific

institutions, markets and individuals that provide the appropriate environment to

perform these activities. The evolution of this system is therefore, the result of lenders and borrowers wishing to make the most out of their situation. With this purpose, funds are to be efficiently transferred between deficit and surplus units that are brought together in order to achieve higher production and efficiency for the economy as a whole. The channelling of funds between the two groups mentioned can only happen accurately in the presence of particular participants and via main routes such as financial intermediaries or through the use of organised financial markets.

The difficulty that lenders (savers) and borrowers (spenders) encounter when confronted with finding and dealing directly with each other has provoked the

appearance of financial intermediaries. These institutions are engaged in bringing the two parties together by borrowing funds from lenders and lending them to borrowers so that both parties find the transaction more favourable than if they traded directly with each other. Financial intermediaries such as banks, investment companies, unit trusus, credit unions and insurance companies pool resources from various small investors so that they can be able to later lend those funds.

It is important to analyze the way not only lenders and savers but also financial

intermediaries benefit from this situation. Economists say that financial intermediaries can substantially reduce transaction costs that can be defined as the time and money spent in performing financial transactions for instance the exchange of assets, goods or services. Because of their large size and expertise, they are able to take advantage of economies of scale. The low transaction costs allow these institutions to offer liquidity services as it is simpler to sell financial instruments to raise cash. In addition, financial intermediaries are able to greatly reduce the exposure to potential risks by sharing the risks among various investors and consequently achieving significant diversification due to the large and varied volume of resources they deal with. In this way, they virtually turn risky assets into safer ones for the benefit of investors and for theirs as well as they gain profits on the difference between the returns and the payments they make.

Another important reason why financial intermediaries play such a significant role

in the financial system is because of the inequality of information available between parties.

Asymmetric information is fundamental to understanding the need for

regulation as it affects the sense of balance that any market needs to remain in a stable situation. Its presence makes it difficult to tell whether the terms of the transactions being held between parties are mutually satisfying and therefore, jeopardizes the solidity of market conditions. Allegedly, financial intermediaries are able to lessen these problems. The reason is that because of the financial involvement in the intermediation process, they are able to screen out bad risks and monitor the utilization of the loans provided.

It is evident that financial intermediaries play a key role in improving the

performance of the economy and are therefore successful elements of the financial

system. Financial markets and institutions embody a mixture of specific elements that are brought together with the sole purpose of controlling and coping with the enormous amount of assets available and the income generated by them.

Ex.6 Read the text, suggest the appropriate title, then prepare a 100- word presentation.

The financial system matches savers and borrowers through two channels: (1) Banks and other financial intermediaries and (2) financial markets. These two channels are distinguished by how funds flow from savers, or lenders, to borrowers and by the financial institutions involved. Funds flow from lenders to borrowers indirectly through financial intermediaries, such as banks, or directly through financial markets. If you get a loan from a bank to buy a car, economists refer to this flow of funds as indirect finance. The flow is indirect because the funds the bank lends you come from people who have put money in checking or savings deposits in the bank; in that sense, the bank is not lending its own funds directly to you. On the other hand, if you buy stock that a firm has just issued, the flow of funds is direct finance because the funds are flowing directly from you to the firm.

Savers and borrowers can be households, firms, or governments, both domestic and foreign. Savers receive their returns in various forms, including dividend payments on stock, coupon payments on bonds, and interest payments on loans.

Financial Intermediaries Commercial banks are the most important financial intermediaries. Commercial banks play a key role in the financial system by taking in deposits from households and firms and investing most of those deposits, either by making loans to households and firms or by buying securities, such as government bonds or securitized loans. Most households rely on borrowing money from banks when they purchase “big-ticket items,” such as cars or homes. Similarly, many firms rely on bank loans to meet their short-term needs for credit, such as funds to pay for inventories or to meet their payrolls. Many firms rely on bank loans to bridge the gap between the time they must pay for inventories or meet their payrolls and when they receive revenues from the sales of goods and services. Some firms also rely on bank loans to meet their long-term credit needs, such as funds they require to physically expand the firm.

Nonbank Financial Intermediaries Some financial intermediaries, such as building societies and credit unions, are legally distinct from banks, although these “nonbanks” operate in a very similar way by taking in deposits and making loans. Other financial intermediaries include insurance companies, pension funds, unit trusts, hedge funds, and merchant (investment) banks. Although these institutions don’t at first glance appear to be very similar to banks, they fulfill a similar function in the financial system by channeling funds from savers to borrowers.

Ex.7. Complete the text with the words and word combination from the box and translate it into Ukrainian.

Policyholders; premiums; invest; costs; automobile insurance policy; retirement; pension benefit payments; investors; portfolio of financial assets; reduce the costs; investment risk; bankruptcy; unit trust’s portfolio; commercial banks; underwriting; buying and selling.

Nonbank Financial Intermediaries:

Insurance companies. Insurance companies specialize in writing contracts to protect their (1)… from the risk of financial losses associated with particular events, such as automobile accidents or fires. Insurance companies collect (2)… from policyholders, which the companies then (3)… to obtain the funds necessary to pay claims to policyholders and to cover their other (4)…. So, for instance, when you and other people buy an(5)…, the insurance company may lend the premiums you pay to a hotel chain that needs funds to expand.

Pension funds. For many people, saving for (6)… is the most important form of saving. Pension funds invest contributions from workers and firms in stocks, bonds, and mortgages to earn the money necessary to pay (7)… during workers’ retirements.

Unit trusts. A unit trust obtains money by selling shares to(8)…. The unit trust then invests the money in a(9)…, such as stocks and bonds, typically charging a small management fee for its services. By buying shares in a unit trust, savers (10)… they would incur if they were to buy many individual stocks and bonds. Small savers who have only enough money to buy a few individual stocks and bonds can also lower their (11)… by buying shares in a unit trust because most unit trusts hold a large number of stocks and bonds. If a firm issuing a stock or a bond declares (12)…, causing the stock or bond to lose all of its value, the effect on a (13)… is likely to be small. The effect might be devastating, though, on a small investor who had invested most of his or her savings in the stock or bond. Because unit trusts are willing to buy back their shares at any time, they also provide savers with easy access to their money.

Merchant (Investment) banks. Investment banks differ from (14)… in that they do not take in deposits and rarely lend directly to households. Instead, they concentrate on providing advice to firms issuing stocks and bonds or considering mergers with other firms. They also engage in(15)…, in which they guarantee a price to a firm issuing stocks or bonds and then make a profit by selling the stocks or bonds at a higher price. In the late 1990s, investment banks increased their importance as financial intermediaries by becoming heavily involved in the securitization of loans, particularly mortgage loans. Investment banks also began to engage in proprietary trading in which they hoped to profit by (16)… securities.

EX.8 Match terms to their definitions

Adverse selection	a)The fact that as the amount of goods and services produced increases, the cost decreases..
Asymmetric information	b)The situation where people or organizations are more likely to take risks because they are protected against the results.
Economy of scale	c)The ease with which an asset can be exchanged for money.
Moral hazard	d)A service the financial system provides that allows savers to spread and transfer risk.
Diversification	e)The problem created by asymmetric information before the transaction occurs. It occurs when the potential borrowers who are the most likely to produce an undesirable (adverse) outcome – the bad credit risks – are the ones who most actively seek out a loan and are thus most likely to be selected.
Risk sharing	f)Information that is known to some people but not to other people.
Liquidity	g)A collection of assets, such as stocks and bonds.
Portfolio	h)Splitting wealth among many different assets to reduce risk.

Ex.9. Agree or disagree.

1. “The structure of the financial systems of most developed countries is basically the same”. Is this statement true, false, or uncertain? Explain your answer.

2. Financial intermediaries minimize he problems that adverse selection and moral hazard pose for the financial system.

3. If there were no asymmetry in the information that a borrower and a lender had, a moral hazard problemwould not exist.

4. Most people prefer to lend money to individuals and businesses in your city through a local bank rather than directly.

5. “In a world without information and transaction costs, financial intermediaries would not exist.” Is this statement true, false, or uncertain? Explain your answer.

EX.10Translate the following text into English.

Кредитна система Великобританії

Загальний огляд. Кредитна система Великобританії є однією з найстаріших та найрозвинутіших у світі. Вона має добре організовану фінансову інфраструктуру та спирається на потужний грошовий ринок у Лондонському Сіті, що має тісні зв’язки з головними фінансовими центрами світової спільноти. Британське законодавство не має обмежень стосовно окремих видів операцій та сфер фінансового обслуговування. Усі кредитно-фінансові інституції можуть укладати будь-які види угод та надавати клієнтам повний обсяг послуг. Хоча фактично у кредитній системі існує чітка спеціалізація: депозитно-позичкова та емісійна функції закріплені за банківським сектором, інвестиційна – за небанківськими інституціями. При цьому всередині банківського сектора також існує чітка спеціалізація. Велику роль у функціонуванні банківської системи Великобританії відіграє високий ступінь самоконтролю фінансових інституцій, суворе дотримання ними звичаїв та традицій, що були напрацьовані банківським співтовариством. У Великобританії до 1979 р. не було спеціальних законів, які б регламентували роботу банків, а контроль за ними мав скритий та неформальний характер. Банки у цій країні регулювалися загальним Законом про акціонерні компанії і мали змогу розвиватися на основі пруденційних, практичних та конкурентних принципів. Саме завдяки відсутності антимонопольного законодавства та жорсткого контролю над злиттям банків у країні було досягнуто високого ступеня концентрації банківського капіталу. Але в останні роки ситуація дещо змінилася у напрямку посилення формальних аспектів регулювання банківської діяльності. Так, згідно з законом 1979 р. було введено обов’язкове ліцензування комерційних банків, засновано загальнонаціональний фонд страхування депозитів. Банківський закон 1987 р. визначив правила надання великих кредитів, порядок банківських зливань тощо. Але і сьогодні контроль над банківською діяльністю у Великобританії залишається менш формальним та жорстким, ніж в інших країнах. Банківська статистика Великобританії розподіляє всі фінансові інституції на дві групи: банківський сектор та небанківські фінансові інституції. До банківського сектора належать: Банк Англії, комерційні (у тому числі клірингові) банки, торговельні банки, облікові (дисконтні) доми, іноземні комерційні банки та ін. Згідно з банківським законодавством в основі банківської системи знаходиться Банк Англії.

Ex.11. Case Study:

The teacher of English gives his students the task to prepare a conference on the topic “The place and role of financial intermediaries in the economy”. They should prepare one main report, followed by a substantial discussion of the problems touched in it.

The following issues need to be discussed:

• The Financial System and Financial Intermediaries.

• The channels of intermediation and the role played by financial intermediaries within this system.

• Advantages and disadvantages of financial intermediation.

• Discuss how the most important types of financial intermediaries operate.

Questions for revision and discussion

1. Provide a short definition of and discuss the following terms: fin system, direct and indirect finance, financial market, financial intermediation, liquidity.

2. Some people have money; some people need money. Explain how the financial system links these people together.

3. Why do financial intermediaries exist? What services do they provide to the public? Are all financial institutions financial intermediaries?

4. How does risk sharing benefit both financial intermediaries and private investors?

5. What are transaction costs? Does financial intermediation increase or decrease financial costs?

6. What are pros and cons of lending to your next-door neighbour rather than putting your surplus funds in a bank?

7. Suppose financial intermediaries did not exist and only direct finance was possible. How would this affect the process of an individual buying a car or a house?