Module 1: Specialness of FIs & The Traditional financial system

Financial Intermediaries

Institutions that facilitate the flow of funds between net savers and net borrowers in the financial system.

Net Savers

Economic agents who save more income than they spend, such as households saving for retirement.

Net Borrowers

Economic agents who spend more than they earn, such as businesses financing growth or households taking loans.

Flow of Funds

The movement of money from net savers to net borrowers through financial markets or financial intermediaries.

Direct Finance

The transfer of funds from net savers to net borrowers through financial markets using securities like bonds and shares.

Financial Markets

Markets where securities such as bonds, shares, and options are issued and traded.

Securities

Financial instruments such as bonds, shares, and options used by borrowers to raise funds.

Risk-Averse Savers

Net savers who prefer low risk and are less likely to invest directly in financial markets.

Financial Intermediation

The process where financial intermediaries collect funds from savers and lend them to borrowers while managing risk.

Role of Financial Intermediaries

To channel funds from net savers to net borrowers while providing savers with safety, liquidity, and a fixed return.

Interest Income

The return paid to savers by financial intermediaries for holding their funds.

Loan Interest

The interest charged by financial intermediaries to borrowers as a source of profit.

Information Asymmetry

A situation where some participants in a transaction have more or better information than others.

Moral Hazard

The risk that an agent behaves more recklessly after a transaction because they are protected from the consequences.

Insurance Moral Hazard

The tendency of insured individuals to take greater risks because losses are covered.

Adverse Selection

The problem where lenders face different borrower risk types and must screen borrowers to avoid lending to high-risk individuals.

Borrower Risk Profiling

The use of metrics and characteristics to classify borrowers by risk level.

Transaction Costs

The costs associated with conducting financial transactions.

Economies of Scale

Cost advantages gained by financial intermediaries through large-volume transactions.

Economies of Scope

Cost efficiencies gained by using the same information to offer multiple financial products.

Conflicts of Interest

Situations where using the same information for multiple products may harm clients or distort incentives.

Fintech Disruption Goal

The attempt by fintech firms to reduce high transaction costs that have remained around 2 percent for over a century.

Liquidity Creation

The ability of banks to use pooled deposits to provide loans and meet withdrawal demands.

Risk Sharing

The spreading of financial risk across many participants through financial intermediaries.

Trust in Financial Intermediaries

The confidence savers must have in financial institutions to deposit their funds.

Public Confidence

The trust required for financial intermediaries to operate effectively in the economy.

Need for Regulation

The requirement for oversight because financial intermediaries are essential to economic stability.

Negative Externalities

Unintended effects of financial failures on parties not involved in the original transaction.

Systemic Risk

The risk that failure of one institution can threaten the entire financial system, as seen in the 2008 crisis.

Financial Regulation

Rules imposed at provincial, federal, and international levels to manage systemic risk.

Functional Perspective

An approach that focuses on what financial institutions do rather than what they are.

Institutional Perspective

An approach that categorizes financial institutions based on their legal structure.

Traditional Four Pillars

Banks, trust companies, insurance companies, and investment dealers under earlier Canadian regulation.

Regulatory Separation

Rules that historically prevented financial institutions from owning or selling each other’s services.

Financial Deregulation

The process that allowed financial institutions to own each other and cross-sell services.

Modern Two Pillars

Banks and insurance companies as the dominant pillars in Canada today.

Bank Ownership of Insurance

The rule allowing banks to own insurance companies while keeping operations separate.

Operational Separation

The requirement that banking and insurance activities cannot be sold or advertised in the same branches.

Depository Institutions

Financial institutions legally permitted to accept deposits from the public.

Chartered Banks

Federally regulated banks authorized to accept deposits and provide loans.

Trust and Mortgage Loan Companies

Depository institutions specializing in trust services and mortgage lending.

Credit Unions

Member-owned depository institutions that provide banking services.

Non-Depository Institutions

Financial institutions that do not accept public deposits.

Contractual Financial Institutions

Institutions such as insurance companies and pension funds that collect funds through contracts.

Life Insurance Companies

Contractual institutions that provide life insurance and long-term savings products.

Property and Casualty Insurance Companies

Insurance institutions that cover risks such as accidents, theft, and damage.

Pension Funds

Institutions that manage retirement savings for employees.

Retirement Funds

Investment vehicles designed to provide income after retirement.

Investment Intermediaries

Non-depository institutions that channel funds into financial markets.

Finance Companies

Institutions that provide loans but do not accept deposits.

Mutual Funds

Investment vehicles that pool funds from investors to buy diversified portfolios.

Hedge Funds

Investment intermediaries using advanced strategies to generate returns.

Investment Banks

Financial institutions that assist with securities issuance, underwriting, and advisory services.