Lecture 9: Credit Markets and Financial Intermediation

Vocabulary and key concepts regarding financial markets, banking roles, and the dynamics of financial crises derived from the Lecture 9 transcript.

Financial Intermediaries

Institutions that connect those with funds they want to save, invest, or give to those who need funds, such as banks, asset managers, or philanthropic organizations.

Bank

A financial intermediary where you make a deposit that can be withdrawn at any time and which provides loans to households and firms.

Asset Manager

An intermediary where investors buy and sell financial securities like stocks and bonds, which can be sold at any time.

Financial Intermediation (Role)

The process of channeling funds from suppliers (savers) to those who demand funds for investment, such as ModeRNA Therapeutics (Moderna) seeking shop setup in 2010.

Payments (Role)

A function of the financial system that allows for the transfer of money between parties, though it can involve errors like Citibank's mistaken wire of $\$893\text{ million}$.

Risk Reduction (Role)

The ability of financial markets to allow agents to hedge risks, such as through insurance, although the system can also be a source of systemic risk like Lehman Brothers.

Price Discovery (Role)

The process where asset market trading determines the fundamental value of companies, increasing the efficiency of capital allocation.

Venture Capital Funds

Firms that provide funding to start-ups, reaching a record of $\$621\text{ billion}$ in 2021; examples include Sequoia and Bessemer.

Maturity

The amount of time until a debt must be repaid.

Maturity Transformation

The process of transforming short-maturity liabilities, like demand deposits, into long-term investments, like mortgages.

Demand Deposits

Bank liabilities with a $0\text{-year}$ maturity because depositors can withdraw their funds at any moment.

Stockholders' Equity

The difference between total assets and total liabilities ($\text{Total assets} - ext{Total liabilities} \equiv \text{Stockholders' equity}$).

Reserves

The combination of vault cash and deposits held by a bank at the Federal Reserve ($\text{Vault Cash} + \text{Deposits at Fed} \equiv \text{Reserves}$).

Diversified Portfolio

A collection of various assets (mortgages, consumer loans, business loans) intended to ensure that different assets are unlikely to underperform at the same time.

Federal Deposit Insurance Corporation (FDIC)

A government agency established in 1933 that insures bank deposits up to $\$250,000$ per person (or $\$500,000$ for joint accounts) to protect depositors.

Solvent

A state where a financial institution's assets are greater than its liabilities (\text{assets} > \text{liabilities}).

Insolvent

A state where a financial institution's assets are less than its liabilities (\text{assets} < \text{liabilities}), often leading to a wipeout of stockholders' equity.

Non-bank Banks

Financial institutions like Lehman Brothers that serve firms and institutional investors but do not have FDIC-insured deposits.

Bank Run

A situation where a substantial number of depositors attempt to withdraw their funds simultaneously, often leading the bank to sell illiquid assets in fire sales.

Fire Sales

The forced sale of illiquid assets where the bank receives less cash than it would obtain by holding the assets until they mature.

Systemically Important Financial Institutions (SIFIs)

Large financial institutions considered "too big to fail" that must pass annual stress tests and hold higher levels of stockholders' equity.