How are banks different from markets in playing the fundamental role of a financial system? What makes banks a more efficient way of channelling funds from the surplus sector to the deficit sector, despite additional costs of intermediation? The purpose of this note is twofold. First, I present a simple model to address several key questions pertaining to financial intermediaries. In particular, I focus on the following questions: (a) what are the key issues in external financing arrangements; (b) what are the costs and benefits of using financial intermediaries; (c) what makes financial intermediaries a robust, viable mechanism? Based on the insight from the theoretical model, I then discuss policy implications for reforming Japan’s banking sector.
Introduction
A Tale of Two Banks
Direct Financing
Financial Intermediation
The Costs and Benefits of Financial Intermediation and Policy Implications
References