Comparative Analysis of English and Bade Proverbs

Comparative Analysis of English and Bade Proverbs COMPARATIVE ANALYSIS OF ENGLISH AND BADE PROVERBS: EXPLORING FORM AND CONTENT It is believed that there is no language without proverbs. Vulic and Zergollern in Valiulyte (2010), corroborate this notion that ‘each nation or country has its own proverbs†. Therefore, every language has its own proverbs which are used by its own speakers through many media as in literature like poetry, prose and drama and other forms of daily communication. Nevertheless, some advanced languages like English have a rich tradition of proverbs, because its proverbs have been collected and analyzed academically. This is probably due to the early civilization of the English people, and their awareness of literature and publication. Consequently, English proverbs have become richer and more widespread, unlike the ones of Bade (a local language in Yobe State, Nigeria) whose proverbs have not received any study worthy of academic recognition. The term proverb has been defined by different scholars in different perspectives. Norrick (1985) defines proverbs as self-sufficient, brief, traditional expression with advisory content and secured poetic form. Meider (1985) sees it as a short, generally known sentence which contains wisdom, truth, with memorable form and which is handed down from generation to generation. According to Tatar (1998), proverbs are concise common expressions with literal and figurative meaning. It can be understood from the above definitions that the term proverb is a terse saying that represents matters of universal truth, with a literal, figurative, or poetic structure, preserved through discourse, and passed on from one generation to another in human society. According to Meider (2004), in Dabaghi, Pishbin and Niknasab (2010), it is hard to identify the origin and history of proverbs. Nevertheless, he adds that proverbs ‘†¦ do not fall from the sky’. Therefore, he observes that there is a similar trend of emergence of proverbs in Europe, Asia, Africa and other linguistic and cultural groups. He traces the origin of European proverbs ‘back to the classical times of Greek and Roman antiquity; the Biblical era; the Medieval Latin, and the mass media’. In tracing the origin of proverbs in Persian languages, religion and literature have been recognized as two sources (Moosavi, 2000, in Dabaghi, Pishbin and Niknasab, 2010). In a rather more specific manner, Ridout and Witting (1969) link the source of modern English proverbs to popular sayings of the common man; borrowing from the Bible and other languages; wise saying of famous literary scholars; turning highly idiomatic expressions into proverbs; and, modern edu cation. Over the years, scholars have agreed that geographical location has some effects on the nature of proverbs. Brown (1983) observes that proverbs emerging from the same zone tend to have common features. The same idea may be noticed in Schuh (2005), stating that indigenous languages in Yobe State share ‘a large number of idioms, lexicon-related expressions’, just like how West African languages share ‘proverbs and riddles, songs and folktales’. Nevertheless, this does not mean that those languages may not have distinct properties that can separate them from one another as different language. Because Bade is one of the focus languages in this research, some characteristics of proverbs that are peculiar to African languages will provide the researcher with some rich data to work on. One very inconvenient aspect of this research is that while available resources on English proverbs are not hard to come by, Bade, being the other target language is badly lacking in literary resources particularly on proverbs on the one hand. On the other hand, it looks interesting that this research will set a precedent in such an area with a serious academic intent. Recently, studies on Verbal Arts posted on Yobe Language Research Project have presented a few collections of proverbs of indigenous languages, with Bole (257 proverbs),Ngizim(230 proverbs), Karekare(32 proverbs),and Ngamo(14 proverbs). In the case of Bade, its collection deals with songs and folktales, with no single proverb attached (Schuh, 2004). Other non-indigenous languages like Kanuri, Fulfulde and Hausa which Schuh sees as widely spoken in the state, are the most widely studied, with the last one topping the list with several pieces of researches about proverbs including a dictionary titled Dictionary of Hausa Proverbs. Hence, these few collections of proverbs on the indigenous languages of the study area will benefit the researcher greatly, by providing him with a platform upon which to study the Bade proverbs easily. The basic aim of this research is to analyze the form and content of English and Bade proverbs. To achieve this, the research aims to address four main questions. Firstly, it tries to determine whether English and Bade proverbs have different form. Secondly, it will address the question of whether there are similarities between the content of English and Bade proverbs. Thirdly, it seeks to establish how English and Bade proverbs are preserved .Fourthly, it will ascertain whether there are differences in terms of cultural materials involved in the construction of English and Bade proverbs. Such questions are directly linked to the main aim of this research. By looking at these differences and similarities, it will be possible to justify this analysis correctly. In order to answer these research questions correctly, theoretical framework is proposed. Initially, there is the need to clarify the variables of this research. This research has two dependent variables-form and content, which depend on the independent variable- English and Bade proverbs. It is often possible that in a piece of research like this, two theories may present better analytical ground. Therefore, I have chosen to be eclectic in method, by using more than one theory in a single research. I will use two Semantic theories: Classical Metaphor will be used to analyze form; and, Topic-Comment Structure Theory to analyze content of all the proverbs in my corpus. These analyses, upon which the remaining questions and objectives will be answered and achieved, will be used to explain the form and content of both English and Bade proverbs. The decision to propose Metaphor is very much connected to its history as having positive effects on literary studies. Norrick (1985) confirms that the essence of metaphor in studies of proverbs can be traced back to Aristotle. Saeed (2004) classifies two approaches of traditional metaphor as Classical and Romantic. He ascribes classical metaphor to Aristotle, as it describes metaphor from figurative and rhetorical perspectives. Romantic metaphor is linked to ‘eighteenth and nineteenth century Romantic’ periods, which define metaphor as possibly common material in language use (Saeed, 2004). To set a focus for the research, the researcher has chosen to position it on classical perspective which directly relates to proverbs studies. Based on classical view, it seems likely that metaphor is a universal feature of proverbs. And since proverbs are characterized by ‘rigid form’, (Norick, 1985), metaphor will be of great advantage in analyzing all the proverbs tha t have figurative form in the corpus of this research. The second theory is called Topic-Comment Structure as stated above. According to Norrick (1985), this theory is attributed to Dundes(1975).He adds that the theorist proposed it due to the disagreement of paremiologists about a unified formula to analyze the content of proverbs. Using some English proverbs such as ‘Like father like son, No rose without a thorn, and Better late than never’, Dundes suggests substitutable variables such as ‘like X like Y, no X without Y, and better x than Y’ respectively. Norrick observes that these variables can be used to substitute any expression in a proverb. Therefore, this researcher will use this theory to interpret the real content of all proverbs in the corpus. This kind of research is not rare in literary studies. Different kinds of proverb research have been conducted by many literary experts in English and other languages in the world. Shariati and Teyabi (2012), in their study A Comparative Study of Proverbs Characteristics of Mesopotamian Language, and Local Dialect of Persian indicate that research in proverbs has been carried out since ‘about 2500 BC’. However, this may not discredit this research as a mere repetition of previous works of experts. Certainly, it will make it even more interesting since so far, I have not found any serious research into Bade proverbs. With this fast growing interest in literature and publication in the age of globalization, the importance of proverbs is realized not only in literary contexts but also in media, politics, religion and several other social transactions. Meider, in Dabaghi, Pishbin and Niknasab, (2010), notes that ‘proverbs obviously contain a lot of common sense, experience, wisdom, and truth, and as such they represent ready- made traditional strategies in oral speech and writing from high literature to the mass media’. Thus, it seems reasonable that for literature to be meaningful, studies of proverbs ought to be taken as important as any other aspect of literary studies. Therefore, through this analysis, this research is set to achieve certain objectives which include the following: to define the formal pattern of English and Bade proverbs; to determine the content of English and Bade proverbs; to unveil the ways of preserving the proverbs of English and Bade; to explain the different cultural material involved in the construction of English and Bade proverbs.

Encounter Between the Hawaiians and Captain Cook Essay -- History Hawa

Encounter Between the Hawaiians and Captain Cook The arguments of Marshall Sahlins and Gananath Obeseyekere with regard to the cross-cultural encounter between Captain Cook and his men demonstrated different viewpoints and beliefs pertaining to whether or not Captain Cook and his men were perceived to be gods by the Hawaiians. Sahlins and Obeyesekere based the validity of Cook’s deification on several factors that will be focused on below. They both used the physical aspects of Captain Cook in relation to his being perceived as a god or not by the Hawaiians. Sahlins and Obeyesekere argued that the light color of Cook’s skin, his having a physical, human form, the different language that he spoke, his cleanliness, and thinness played a role in how the natives perceived Cook. Sahlins and Obeyesekere also discussed the question of whether or not Cook’s arrival occurred during the Makahiki festival and how this would have affected the views of the natives. The natives could have paralled Cook’s visit with th e return of Lono during this festival, or they could have found to many discrepancies between their beliefs and what they actually observed to believe that Cook was Lono or even a god at all. Both men also attempted to determine whether or not the natives viewed Cook as a god using their own theories of how the Hawaiians thought. Sahlins held the belief that the natives perceived Cook and his men to be gods using his theory of stereotypic reproduction. He defined this theory as a â€Å"society replicating past structures by fitting in present events into pregiven categories†.1 On the other hand, Obeyesekere believed that this wasn’t so, arguing with his theory of practical rationality, which he defined as the common, biological cha... ... Think: About Captain Cook, For Example (The University of Chicago Press, 1995), 245. 2. Gananath Obeyesekere, The Apotheosis of Captain Cook: European Mythmaking in The Pacific (Princeton University Press, 1997), 19. 3. Gananath Obeyesekere, The Apotheosis of Captain Cook, 61. 4. Gananath Obeyesekere, The Apotheosis of Captain Cook, 63, 64. 5. Marshall Sahlins, How "Natives" Think, 6, 8. 6. Gananath Obeyesekere, The Apotheosis of Captain Cook, 65. 7. Marshall Sahlins, How "Natives" Think, 171. 8. Marshall Sahlins, How "Natives" Think, 77. 9. Gananath Obeyesekere, The Apotheosis of Captain Cook, 59. 10. Marshall Sahlins, How "Natives" Think, 32, 33. 11. Marshall Sahlins, How "Natives" Think, 227. 12. Gananath Obeyesekere, The Apotheosis of Captain Cook, 61. 13. Gananath Obeyesekere, The Apotheosis of Captain Cook, 64.

Goldings View of Man and War Exposed in Lord of the Flies :: Lord Flies Essays

Golding's View of Man and War Exposed in Lord of the Flies "...Ralph wept for the end of innocence, the darkness of man's heart" (Golding 223). An author's view of human behavior is often reflected in their writing. The novel, Lord of the Flies, by William Golding is an example of a literary work that demonstrates the author's view of man, as well his opinion of war. Golding's Lord of the Flies is highly demonstrative of Golding's opinion that society is a thin and fragile veil that when removed shows man for what he truly is, a savage animal. Perhaps the best demonstration of this given by Golding is Jack's progression to the killing of the sow. Upon first landing on the island Jack, Ralph, and Simon go to survey their new home. Along the way the boys have their first encounter with the island's pigs. They see a piglet caught in some of the plants. Quickly Jack draws his knife so as to kill the piglet. Instead of completing the act, however, Jack hesitates. Golding states that, "The pause was only long enough for them to realize the enormity of what the downward stroke would be" (Golding page #). Golding is suggesting that the societal taboos placed on killing are still ingrained within Jack. The next significant encounter in Jack's progression is his first killing of a pig. There is a description of a great celebration. The boys chant "Kill the pig. Cut her throat. Spill her blood" (Golding page #). It is clear from Golding's description of the revelry that followed the killing that the act of the hunt provided the boys with more than food. The action of killing another living thing gives them pleasure. The last stage in Jack's metamorphosis is demonstrated by the murder of the sow. Golding describes the killing almost as a rape. He says, "Jack was on top of the sow, stabbing downward wherever pig flesh appeared ... Jack found the throat, and the hot blood spouted over his hands. The sow collapsed under them and they were heavy and fulfilled upon her" (Golding page #). In this case it is certain that the boys display animal savagery. Because they have been away from organized society for such a long time, the boys of the island have become Golding's view of mankind, vile, destructive beasts.

Debate

The McDonald's Scalding Coffee Case is a case for compensatory and punitive damages filed by a 79-year-old woman, Stella Liebeck, who suffered from third degree burns as a result of spilled McDonald’s coffee on her body. The jury awarded Liebeck with $200,000 in compensatory damages and $2.7 million in punitive damages. These amounts were later reduced, but the general conclusion is that McDonald’s was severely punished for serving very hot coffee that led to serious injury. McDonald's coffee is scalding because it is maintained at 180 to 190 degrees Fahrenheit to maintain optimum taste. The temperature of McDonald’s is glaringly high compared to the normal temperature of coffee when prepared at home, which is only about 135 to 140 degrees Fahrenheit. Despite this fact, the case is worth revisiting because there are certain arguments worth pursuing, which could lessen or remove entirely the liability of McDonald’s. It should be remembered that coffee should naturally be served hot, unless the customer asked for other types of coffee, which should be served cold. Therefore, while companies such as McDonald’s have certain responsibilities to their consumers, the latter also have responsibility to their own selves, particularly in ensuring that they would exercise diligence in their handling or consumption of purchased food. In the case described above, it is clear that Liebeck did not exercise due diligence in her handling of the coffee. With full knowledge that the coffee was hot, she placed the Styrofoam cup containing the coffee between her knees. She should have exercised more prudence considering that she was sitting in a car and she placed the cup between her knees, both circumstances contributing to the lack of stability to the cup. Moreover, Liebeck did not consider that she was already old and her body is no longer in top shape. She should have exercised more care in her actions to prevent any kind of injury. References American Association for Justice. McDonald's Scalding Coffee Case. Retrieved   February 5, 2008 Lectric Law Library. The Actual Facts About The McDonald’s' Coffee Case. Retrieved   February 5, 2008, from http://www.lectlaw.com/files/cur78.htm          Debate The McDonald's Scalding Coffee Case is a case for compensatory and punitive damages filed by a 79-year-old woman, Stella Liebeck, who suffered from third degree burns as a result of spilled McDonald’s coffee on her body. The jury awarded Liebeck with $200,000 in compensatory damages and $2.7 million in punitive damages. These amounts were later reduced, but the general conclusion is that McDonald’s was severely punished for serving very hot coffee that led to serious injury. McDonald's coffee is scalding because it is maintained at 180 to 190 degrees Fahrenheit to maintain optimum taste. The temperature of McDonald’s is glaringly high compared to the normal temperature of coffee when prepared at home, which is only about 135 to 140 degrees Fahrenheit. Despite this fact, the case is worth revisiting because there are certain arguments worth pursuing, which could lessen or remove entirely the liability of McDonald’s. It should be remembered that coffee should naturally be served hot, unless the customer asked for other types of coffee, which should be served cold. Therefore, while companies such as McDonald’s have certain responsibilities to their consumers, the latter also have responsibility to their own selves, particularly in ensuring that they would exercise diligence in their handling or consumption of purchased food. In the case described above, it is clear that Liebeck did not exercise due diligence in her handling of the coffee. With full knowledge that the coffee was hot, she placed the Styrofoam cup containing the coffee between her knees. She should have exercised more prudence considering that she was sitting in a car and she placed the cup between her knees, both circumstances contributing to the lack of stability to the cup. Moreover, Liebeck did not consider that she was already old and her body is no longer in top shape. She should have exercised more care in her actions to prevent any kind of injury. References American Association for Justice. McDonald's Scalding Coffee Case. Retrieved   February 5, 2008 Lectric Law Library. The Actual Facts About The McDonald’s' Coffee Case. Retrieved   February 5, 2008, from http://www.lectlaw.com/files/cur78.htm         

The Theory of Financial Intermediation:

THE THEORY OF FINANCIAL INTERMEDIATION: AN ESSAY ON WHAT IT DOES (NOT) EXPLAIN by Bert Scholtens and Dick van Wensveen SUERF – The European Money and Finance Forum Vienna 2003 CIP The Theory of Financial Intermediation: An Essay On What It Does (Not) Explain by Bert Scholtens, and Dick van Wensveen Vienna: SUERF (SUERF Studies: 2003/1) ISBN 3-902109-15-7 Keywords: Financial Intermediation, Corporate Finance, Assymetric Information, Economic Development, Risk Management, Value Creation, Risk Transformation. JELclassificationnumbers: E50,G10,G20,L20,O16  © 2003 SUERF, ViennaCopyright reserved. Subject to the exception provided for by law, no part of this publication may be reproduced and/or published in print, by photocopying, on microfilm or in any other way without the written consent of the copyright holder(s); the same applies to whole or partial adaptations. The publisher retains the sole right to collect from third parties fees payable in respect of copying and/or take l egal or other action for this purpose. THE THEORY OF FINANCIAL INTERMEDIATION AN ESSAY ON WHAT IT DOES (NOT) EXPLAIN+ by Bert Scholtens* Dick van Wensveen†  Also read: Theories Seen in OjtAbstract This essay reflects upon the relationship between the current theory of financial intermediation and real-world practice. Our critical analysis of this theory leads to several building blocks of a new theory of financial intermediation. Current financial intermediation theory builds on the notion that intermediaries serve to reduce transaction costs and informational asymmetries. As developments in information technology, deregulation, deepening of financial markets, etc. end to reduce transaction costs and informational asymmetries, financial intermediation theory shall come to the conclusion that intermediation becomes useless. This contrasts with the practitioner’s view of financial intermediation as a value-creating economic process. It also conflicts with the continuing and increasing economic importance of financial intermediaries. From this paradox, we conclude that current financial intermediation theory fails to provide a satisf actory understanding of the existence of financial intermediaries. We wish to thank Arnoud Boot, David T. Llewellyn, Martin M. G. Fase and Robert Merton for their help and their stimulating comments. However, all opinions reflect those of the authors and only we are responsible for mistakes and omissions. * Associate Professor of Financial Economics at the University of Groningen; PO Box 800; 9700AVGroningen;TheNetherlands(correspondingauthor). †  Professor of Financial Institutions at the Erasmus University of Rotterdam; PO Box 1738; 3000 DR Rotterdam; The Netherlands, (former Chairman of the Managing Board of MeesPierson).We present building blocks for a theory of financial intermediation that aims at understanding and explaining the existence and the behavior of real-life financial intermediaries. When information asymmetries are not the driving force behind intermediation activity and their elimination is not the commercial motive for financial intermediaries, the question arises which paradigm, as an alternative, could better express the essence of the intermediation process. In our opinion, the concept of value creation in the context of the value chain might serve that purpose.And, in our opinion, it is risk and risk management that drives this value creation. The absorption of risk is the central function of both banking and insurance. The risk function bridges a mismatch between the supply of savings and the demand for investments as savers are on average more risk averse than real investors. Risk, that means maturity risk, counterparty risk, market risk (interest rate and stock prices), life expectancy, income expectancy risk etc. , is the core business of the financial industry.Financial intermediaries can absorb risk on the scale required by the market because their scale permits a sufficiently diversified portfolio of investments needed to offer the security required by savers and policyholders. Financial intermediaries are not just agents wh o screen and monitor on behalf of savers. They are active counterparts themselves offering a specific product that cannot be offered by individual investors to savers, namely cover for risk. They use their reputation and their balance sheet and off-balance sheet items, rather than their very limited own funds, to act as such counterparts.As such, they have a crucial function within the modern economy. TABLE OF CONTENTS 1. Introduction7 2. The Perfect Model9 3. Financial Intermediaries in the Economy11 4. Modern Theories of Financial Intermediation15 5. Critical Assessment21 6. An Alternative Approach of Financial Intermediation31 7. Building Blocks for an Amended Theory37 8. A New Research Agenda41 References45 Appendix A53 Tables 1. Share of Employment in Financial Services in Total Employment (percentages)12 2. Share of Value-Added in Financial Services in GDP (percentages)12 3.Financial Intermediary Development over Time for About 150 Countries (percentages)12 4. (Stylized) Conte mporary and Amended Theory of Financial Intermediation38 SUERF56 SUERF Studies57 1. Introduction When a banker starts to study the theory of financial intermediation in order to better understand what he has done during his professional life, he enters a world unknown to him. That world is full of concepts which he did not, or hardly, knew before and full of expressions he never used himself: asymmetric information, adverse selection, monitoring, costly state verification, moral hazard and a couple more of the same kind.He gets the uneasy feeling that a growing divergence has emerged between the micro- economic theory of banking, as it took shape in the last three decades, and the everyday behavior of bankers according to their business motives, expressed in the language they use. This essay tries to reflect on the merits of the present theory of financial intermediation, on what it does and does not explain from both a practical and a theoretical point of view. The theory is impres sive by the multitude of applications in the financial world of the agency theory and the theory of asymmetric information, of adverse selection and moral hazard.As well as by their relevance for important aspects of the financial intermediation process, as is shown in an ever-growing stream of economic studies. But the study of all these theories leaves the practitioner with the impression that they do not provide a satisfactory answer to the basic question; which forces really drive the financial intermediation process? The current theory shows and explains a great variety in the behavior of financial intermediaries in the market in their relation to savers and to investors/entrepreneurs.But as far as the authors of this essay are aware, it does not, or not yet, provide a satisfactory answer to the question of why real-life financial institutions exist, what keeps them alive and what is their essential contribution to (inter)national economic welfare. We believe that this question cannot be addressed by a further extension of the present theory, by the framework of the agency theory and the theory of asymmetric information. The question goes into the heart of the present theory, into the paradigm on which it is based.This paradigm is the famous classical idea of the perfect market, introduced by Marshall and Walras. Since then, it has been the leading principle, the central point of reference in the theory of competition, the neoclassical growth theory, the portfolio theory and also the leading principle of the present theory of financial intermediation. Financial intermediaries, according to that theory, have a function only because financial markets are not perfect. They exist by the grace of market 7 8Introduction imperfections.As long as there are market imperfections, there are intermediaries. As soon as markets are perfect, intermediaries are redundant; they have lost their function because savers and investors dispose of the perfect information needed to find each other directly, immediately and without any impediments, so without costs, and to deal at optimal prices. This is the general equilibrium model a la Arrow-Debreu in which banks cannot exist. Obviously, this contrasts with the huge economic and social importance of financial intermediaries in highly developed modern economies.Empirical observations point at an increasing role for financial intermediaries in economies that experience vastly decreasing information and transaction costs. Our essay goes into this paradox and comes up with an amendment of the existing theory of financial intermediation. The structure of this paper is as follows. First, we introduce the foundations of the modern literature of financial intermediation theory. From this, we infer the key predictions with respect to the role of the financial intermediary within the economy.In Section 3, we will investigate the de facto role of financial intermediaries in modern economies. We discuss views on the theoretical relevance of financial intermediaries for economic growth. We also present some stylized facts and empirical observations about their current position in the economy. The mainstream theory of financial intermediation is briefly presented in Section 4. Of course, we cannot pay sufficient attention to all developments in this area but will focus on the basic rationales for financial intermediaries according to this theory, i. . information problems, transaction costs, and regulation. Section 5 is a critical assessment of this theory of financial intermediation. An alternative approach of financial intermediation is unfolded in Section 6. In Section 7, we present the main building blocks for an alternative theory of financial intermediation that aims at understanding and explaining the behavior of real-life financial intermediaries. Here, we argue that risk management is the core issue in understanding this behavior.Transforming risk for ultimate savers and lenders and ris k management by the financial intermediary itself creates economic value, both for the intermediary and for its client. Accordingly, it is the transformation and management of risk that is the intermediaries’ contribution to the economic welfare of the society it operates in. This is – in our opinion – the hidden or neglected economic rationale behind the emergence and the existence and the future of real-life financial intermediaries.In Section 8, we conclude our essay with a proposal for a research agenda for an amended theory of financial intermediation. 2. The Perfect Model Three pillars are at the basis of the modern theory of finance: optimality, arbitrage, and equilibrium. Optimality refers to the notion that rational investors aim at optimal returns. Arbitrage implies that the same asset has the same price in each single period in the absence of restrictions. Equilibrium means that markets are cleared by price adjustment – through arbitrage â€⠀œ at each moment in time.In the neoclassical model of a perfect market, e. g. the perfect market for capital, or the Arrow-Debreu world, the following criteria usually must be met: –no individual party on the market can influence prices; – conditions for borrowing/lending are equal for all parties under equal circumstances; –there are no discriminatory taxes; –absence of scale and scope economies; –all financial titles are homogeneous, divisible and tradable; – there are no information costs, no transaction costs and no insolvency costs; –all market parties have ex ante nd ex post immediate and full information on all factors and events relevant for the (future) value of the traded financial instruments. The Arrow-Debreu world is based on the paradigm of complete markets. In the case of complete markets, present value prices of investment projects are well defined. Savers and investors find each other because they have perfect inform ation on each others preferences at no cost in order to exchange savings against readily available financial instruments.These instruments are constructed and traded costlessly and they fully and simultaneously meet the needs of both savers and investors. Thus, each possible future state of the world is fully covered by a so-called Arrow-Debreu security (state contingent claim). Also important is that the supply of capital instruments is sufficiently diversified as to provide the possibility of full risk diversification and, thanks to complete information, market parties have homogenous expectations and act rationally.In so far as this does not occur naturally, intermediaries are useful to bring savers and investors together and to create instruments that meet their needs. They do so with reimbursement of costs, but costs are by definition an element – or, rather, characteristic – of market imperfection. Therefore, intermediaries are at best tolerated and would be elim inated in a move towards market perfection, with all intermediaries becoming 9 10The Perfect Model redundant: the perfect state of disintermediation. This model is the starting point in the present theory of financial intermediation.All deviations from this model which exist in the real world and which cause intermediation by the specialized financial intermediaries, are seen as market imperfections. This wording suggests that intermediation is something which exploits a situation which is not perfect, therefore is undesirable and should or will be temporary. The perfect market is like heaven, it is a teleological perspective, an ideal standard according to which reality is judged. As soon as we are in heaven, intermediaries are superfluous. There is no room for them in that magnificent place.Are we going to heaven? Are intermediaries increasingly becoming superfluous? One would be inclined to answer both questions in the affirmative when looking to what is actually happening: Incre asingly, we have to make do with liberalized, deregulated financial markets. All information on important macroeconomic and monetary data and on the quality and activities of market participants is available in ‘real time’, on a global scale, twenty-four hours a day, thanks to the breathtaking developments in information and communication technology.Firms issue shares over the Internet and investors can put their order directly in financial markets thanks to the virtual reality. The communication revolution also reduces information costs tremendously. The liberalization and deregulation give, moreover, a strong stimulus towards the securitization of financial instruments, making them transparent, homogeneous, and tradable in the international financial centers in the world. Only taxes are discriminating, inside and between countries. Transaction costs are still there, but they are declining in relative importance thanks to the cost efficiency of ICT and efficiencies of scale.Insolvency and liquidity risks, however, still are an important source of heterogeneity of financial titles. Furthermore, every new crash or crisis invokes calls for additional and more timely information. For example, the Asia crisis resulted in more advanced and verifiable and controllable international financial statistics, whereas the Enron debacle has put the existing business accounting and reporting standards into question. There appears to be an almost unstoppable demand for additional information. 3. Financial Intermediaries in the EconomySo, we are making important progress in our march towards heaven and what happens? Is financial intermediation fading away? One might think so from the forces shaping the current financial environment: deregulation and liberalization, communication, internationalization. But what is actually happening in the real world? Do we really witness the demise of the financial institutions? Are the intermediaries about to vanish from planet E arth? On the contrary, their economic importance is higher than ever and appears to be increasing.This is the case even during the 1990s when markets became almost fully liberalized and when communication on a global scale made a real and almost complete breakthrough. The tendency towards an increasing role of financial intermediation is illustrated in Tables 1 and 2 that give the relative contribution of the financial sector to the two key items of economic wealth and welfare in most nations, i. e. GDP and labor. These tables show that, even in highly developed markets, financial intermediaries tend to play a substantial and increasing role in the current economy.Furthermore, Demirguc-Kunt and Levine (1999) among others, conclude that claims of deposit money banks and of other financial institutions on the private sector have steadily increased as a percentage of GDP in a large number of countries (circa 150), rich and poor, between the 1960s and 1990s. The pace of increase is not declining in the 1990s. This is reflected in Table 3. In the 1960s, Raymond Goldsmith (1969) gave stylized facts on financial structure and economic development (see appendix A). He found that in the course of economic development, a country’s financial system grows more rapidly than national wealth.It appears that the main determinant of the relative size of a country’s financial system is the separation of the functions of saving and investing among different (groups of) economic units. This observation sounds remarkably modern. Since the early 1990s, there has been growing recognition for the positive impact of financial intermediation on the economy. Both theoretical and empirical studies find that a well-developed financial system is beneficial to the economy as a whole. Basically the argument behind this idea is that the efficient allocation of capital within an economy fosters economic growth (see Levine, 1997).Financial intermediation can affect economic growth by acting on the saving rate, on the fraction of saving channeled to investment or on the social marginal productivity of investment. In general, financial development will be positive for economic growth. But some improvements in risk-sharing and in the 11 12Financial Intermediaries in the Economy credit market for households may decrease the saving rate and, hence, the growth rate (Pagano, 1993). Table 1: Share of Employment in Financial Services in Total Employment (percentages) Source: OECD, National Accounts (various issues)Table 2: Share of Value-Added in Financial Services in GDP (percentages) Source: OECD, National Accounts (various issues) Table 3: Financial Intermediary Development over Time for About 150 Countries (percentages) Source: Demirguc-Kunt and Levine (1999, Figure 2A) 1970 1980 1985 1990 1995 2000 Canada 2. 4 2. 7 2. 9 3. 0 3. 2 3. 1 France 1. 8 2. 6 2. 9 2. 8 2. 7 2. 8 Germany 2. 2 2. 8 3. 0 3. 1 3. 3 3. 3 Japan 2. 4 3. 0 3. 2 3. 3 3. 4 3. 5 Switzerland â€⠀œ – 4. 6 4. 8 4. 8 4. 9 United Kingdom – 3. 0 3. 5 4. 6 4. 4 4. 4 United States 3. 8 4. 4 4. 7 4. 8 4. 8 4. 8 1970 980 1985 1990 1995 2000 Canada 2. 2 1. 8 2. 0 2. 8 2. 9 3. 1 France 3. 5 4. 4 4. 8 4. 4 4. 6 4. 8 Germany 3. 2 4. 5 5. 5 4. 8 5. 8 5. 7 Japan 4. 3 4. 5 5. 5 4. 8 5. 6 5. 3 Netherlands 3. 1 4. 0 5. 3 5. 6 5. 5 5. 8 Switzerland – – 10. 4 10. 3 13. 1 12. 8 United States 4. 0 4. 8 5. 5 6. 1 7. 2 7. 1 1960s 1970s 1980s 1990s Liquid liabilities/GDP 32 39 47 51 Claims by deposit money banks on private sector/GDP 20 24 32 39 Financial Intermediaries in the Economy13 There are different views on how the financial structure affects economic growth exactly (Levine, 2000). The bank-based view holds that bank-based systems – particularly at early stages of economic development – foster economic growth to a greater degree than market-based systems. ? The market-based view emphasizes that markets provide key financial services that stimulate innovation and long-run growth. ? The financial services view stresses the role of banks and markets in researching firms, exerting corporate control, creating risk management devices, and mobilizing society’s savings for the most productive endeavors in tandem.As such, it does regard banks and markets as complements rather than substitutes as it focuses on the quality of the financial services produced by the entire financial system. ? The legal-based view rejects the analytical validity of the financial structure debate. It argues that the legal system shapes the quality of financial services (for example La Porta et al. , 1998). The legal-based view stresses that the component of financial development explained by the legal system critically influences long-run growth.Political factors have been introduced too, in order to explain the relationship between financial and economic development (see Fohlin, 2000; Kroszner and Strahan, 2000; Rajan and Zingales, 2000). From empir ical research of the relationship between economic and financial development, it appears that history and path-dependency weigh very heavy in determining the growth and design of financial institutions and markets. Furthermore, idiosyncratic shocks that surprise institutions and markets over time appear to be quite important.Despite obvious connections among political, legal, economic, and financial institutions and markets, long-term causal relationships often prove to be elusive and appear to depend upon the methodology chosen to study the relationship. 1 But it is important to realize that efficient financial intermediation confers two important benefits: it raises 1 For example, see Berthelemy and Varoudakis, 1996; Demetriades and Hussein, 1996; Kaplan and Zingales, 1997; Sala-i-Martin, 1997; Fazzari et al. , 1988; Levine and Zervos, 1998; Demirguc-Kunt and Levine, 1999; Filer et al, 1999; Beck and Levine, 2000; Beck et al. 2000; Benhabib and Spiegel, 2000; Demirguc-Kunt and Mak simovic, 2000; Rousseau and Wachtel, 2000; Arestis et al. , 2001; Wachtel, 2001. 14Financial Intermediaries in the Economy the level of investment and savings, and it increases the efficiency in the allocation of financial funds in the economic system. There is a structural tendency in the composition of national wealth represented in financial titles in many countries, especially the Anglo Saxon, towards the substitution of bank held assets (bank loans etc. ) by securitized assets held by the public (equity, bonds) (Ross, 1989).This substitution is often interpreted as a proof of the disintermediation process (e. g. Allen and Santomero, 1997). However, this substitution does not imply that bank loans are not growing any more. To the contrary, they continue to grow, even in the U. S. where the substitution is most visible (see Boyd and Gertler, 1994; Berger et al. , 1995). Therefore, this substitution may not be interpreted as a sign of a diminishing role of banking in general. This is because it is the banks that play an essential role in the securitized instruments.They initiate, arrange and underwrite the floating of these instruments. They often maintain a secondary market. They invent a multitude of off-balance instruments derived from securities. They provide for the clearing of the deals. They are the custodians of these constructions. They provide stock lending and they finance market makers in options and futures. Thus, banks are crucial drivers of financial innovation. Furthermore, it is still an unsolved question of how the off-balance instruments should be counted in the statistics of national wealth.Their huge notional amounts do not reflect the constantly varying values for the contracting parties. Banks are moving in an off-balance direction and their purpose is increasingly to develop and provide tradable and non-tradable risk management instruments. And other kinds of financial intermediaries play an increasingly important role in the same dir ection, both in securitized and non-tradable instruments, both on- and off-balance: insurance companies, pension funds, investments funds, market makers at stock exchanges and derivative markets.These different kinds of financial intermediaries transform risk (concerning future income or accidents or interest rate fluctuations or stock price fluctuations, etc. ). Risk transformation and risk management is their job. Thus, despite the globalization of financial services, driven by deregulation and information technology ,and despite strong price competition, the financial services industry is not declining in importance but it is growing. This seems paradoxical. It points to something important which the modern financial intermediation theory, and the neo-classical market theory on which it is based, do not explain.Might it be the case that it overlooks something crucial? Something that is to be related to information production but that is, so far, not uncovered by the theory of fin ancial intermediation? 4. Modern Theories of Financial Intermediation In order to give firm ground to our argument and to illustrate the paradox, we will first review the doctrines of the theory of financial intermediation. 2 These are specifications, relevant to the financial services industry, of the agency theory, and the theory of imperfect or asymmetric information.Basically, we may distinguish between three lines of reasoning that aim at explaining the raison d’etre of financial intermediaries: information problems, transaction costs and regulatory factors. First, and that used in most studies on financial intermediation, is the informational asymmetries argument. These asymmetries can be of an ex ante nature, generating adverse selection, they can be interim, generating moral hazard, and they can be of an ex post nature, resulting in auditing or costly state verification and enforcement. The informational asymmetries generate market imperfections, i. . deviations from the neoclassical framework in Section 2. Many of these imperfections lead to specific forms of transaction costs. Financial intermediaries appear to overcome these costs, at least partially. For example, Diamond and Dybvig (1983) consider banks as coalitions of depositors that provide households with insurance against idiosyncratic shocks that adversely affect their liquidity position. Another approach is based on Leland and Pyle (1977). They interpret financial intermediaries as information sharing coalitions.Diamond (1984) shows that these intermediary coalitions can achieve economies of scale. Diamond (1984) is also of the view that financial intermediaries act as delegated monitors on behalf of ultimate savers. Monitoring will involve increasing returns to scale, which implies that specializing may be attractive. Individual households will delegate the monitoring activity to such a specialist, i. e. to the financial intermediary. The households will put their deposits with the i ntermediary. They may withdraw the deposits in order to discipline the intermediary in his monitoring function.Furthermore, they will positively value the intermediary’s involvement in the ultimate investment (Hart, 1995). Also, there can be assigned a positive incentive effect of short-term debt, and in particular deposits, on bankers (Hart and Moore, 1995). For example, Qi (1998) and Diamond and Rajan (2001) show that deposit finance can create 2 We have used the widely cited reviews by Allen, 1991; Bhattacharya and Thakor, 1993; Van Damme, 1994; Freixas and Rochet 1997; Allen and Gale, 2000b; Gorton and Winton, 2002, as our main sources in this section. 15 6Modern Theories of Financial Intermediation the right incentives for a bank’s management. Illiquid assets of the bank result in a fragile financial structure that is essential for disciplining the bank manager. Note that in the case households that do not turn to intermediated finance but prefer direct finance, t here is still a â€Å"brokerage† role for financial intermediaries, such as investment banks (see Baron, 1979 and 1982). Here, the reputation effect is also at stake. In financing, both the reputation of the borrower and that of the financier are relevant (Hart and Moore, 1998).Dinc (2001) studies the effects of financial market competition on a bank reputation mechanism, and argues that the incentive for the bank to keep its commitment is derived from its reputation, the number of competing banks and their reputation, and the competition from bond markets. These four aspects clearly interact (see also Boot, Greenbaum and Thakor, 1993). The â€Å"informational asymmetry† studies focus on the bank/borrower and the bank/lender relation in particular. In bank lending one can basically distinguish transactions-based lending (financial statement lending, asset- based lending, credit scoring, etc. ) and relationship lending.In the former class information that is relatively easily available at the time of loan origination is used. In the latter class, data gathered over the course of the relationship with the borrower is used (see Lehman and Neuberger, 2001; Kroszner and Strahan, 2001; Berger and Udell, 2002). Central themes in the bank/borrower relation are the screening and monitoring function of banks (ex ante information asymmetries), the adverse selection problem (Akerlof, 1970), credit rationing (Stiglitz and Weiss, 1981), the moral hazard problem (Stiglitz and Weiss, 1983) and the ex post verification problem (Gale and Hellwig, 1985).Central themes in the bank/lender relation are bank runs, why they occur, how they can be prevented, and their economic consequences (Kindleberger, 1989; Bernanke, 1983; Diamond and Dybvig, 1983). Another avenue in the bank/lender relationship are models for competition between banks for deposits in relation to their lending policy and the probability that they fulfill their obligations (Boot, 2000; Diamond and Raja n, 2001). Second is the transaction costs approach (examples are Benston and Smith, 1976; Campbell and Kracaw, 1980; Fama, 1980).In contrast to the first, this approach does not contradict the assumption of complete markets. It is based on nonconvexities in transaction technologies. Here, the financial intermediaries act as coalitions of individual lenders or borrowers who exploit economies of scale or scope in the transaction technology. The notion of transaction costs encompasses not only exchange or monetary transaction costs (see Tobin, 1963; Towey, 1974; Fischer, 1983), but also search costs and monitoring and auditing costs (Benston and Smith, 1976). Here, the role of Modern Theories of Financial Intermediation17 he financial intermediaries is to transform particular financial claims into other types of claims (so-called qualitative asset transformation). As such, they offer liquidity (Pyle, 1971) and diversification opportunities (Hellwig, 1991). The provision of liquidity is a key function for savers and investors and increasingly for corporate customers, whereas the provision of diversification increasingly is being appreciated in personal and institutional financing. Holmstrom and Tirole (2001) suggest that this liquidity should play a key role in asset pricing theory.The result is that unique characteristics of bank loans emerge to enhance efficiency between borrower and lender. In loan contract design, it is the urge to be able to efficiently bargain in later (re)negotiations, rather than to fully assess current or expected default risk that structures the ultimate contract (Gorton and Kahn, 2000). With transaction costs, and in contrast to the information asymmetry approach, the reason for the existence of financial intermediaries, namely transaction costs, is exogenous. This is not fully the case in the third approach.The third approach to explain the raison d’etre of financial intermediaries is based on the regulation of money production and of saving in and financing of the economy (see Guttentag and Lindsay, 1968; Fama, 1980; Mankiw, 1986; Merton, 1995b). Regulation affects solvency and liquidity with the financial institution. Diamond and Rajan (2000) show that bank capital affects bank safety, the bank’s ability to refinance, and the bank’s ability to extract repayment from borrowers or its willingness to liquidate them.The legal-based view especially (see Section 3), sees regulation as a crucial factor that shapes the financial economy (La Porta et al. , 1998). Many view financial regulations as something that is completely exogenous to the financial industry. However, the activities of the intermediaries inherently â€Å"ask for regulation†. This is because they, the banks in particular, by the way and the art of their activities (i. e. qualitative asset transformation), are inherently insolvent and illiquid (for the example of deposit insurance, see Merton and Bodie, 1993).Furthermore, mo ney and its value, the key raw material of the financial services industry, to a large extent is both defined and determined by the nation state, i. e. by regulating authorities par excellence. Safety and soundness of the financial system as a whole and the enactment of industrial, financial, and fiscal policies are regarded as the main reasons to regulate the financial industry (see Kareken, 1986; Goodhart, 1987; Boot and Thakor, 1993).Also, the financial history shows a clear interplay between financial institutions and markets and the regulators, be it the present-day specialized financial supervisors or the old-fashioned sovereigns (Kindleberger, 1993). Regulation of financial intermediaries, especially of banks, is costly. There are the direct costs of administration and of employing the supervisors, and 18Modern Theories of Financial Intermediation there are the indirect costs of the distortions generated by monetary and prudential supervision.Regulation however, may also gene rate rents for the regulated financial intermediaries, since it may hamper market entry as well as exit. So, there is a true dynamic relationship between regulation and financial production. It must be noted that, once again, most of the literature in this category focuses on explaining the functioning of the financial intermediary with regulation as an exogenous force. Kane (1977) and Fohlin (2000) attempt to develop theories that explain the existence of the very extensive regulation of financial intermediaries when they go into the dynamics of financial regulation. Thus, to summarize, according to the modern theory of financial intermediation, financial intermediaries are active because market imperfections prevent savers and investors from trading directly with each other in an optimal way. The most important market imperfections are the informational asymmetries between savers and investors. Financial intermediaries, banks specifically, fill – as agents and as delegated monitors – information gaps between ultimate savers and investors. This is because they have a comparative informational advantage over ultimate savers and investors.They screen and monitor investors on behalf of savers. This is their basic function, which justifies the transaction costs they charge to parties. They also bridge the maturity mismatch between savers and investors and facilitate payments between economic parties by providing a payment, settlement and clearing system. Consequently, they engage in qualitative asset transformation activities. To ensure the sustainability of financial intermediation, safety and soundness regulation has to be put in place. Regulation also provides the basis for the intermediaries to enact in the production of their monetary services.All studies on the reasons behind financial intermediation focus on the functioning of intermediaries in the intermediation process; they do not examine the existence of the real-world intermediaries as s uch. It appears that the latter issue is regarded to be dealt with when satisfactory answers on the former are being provided. Market optimization is the main point of reference 3 The importance of regulation for the existence of the financial intermediary can best be understood if one is prepared to account for the historical and institutional setting of financial intermediation (see Kindleberger, 1993; Merton, 1995b).Interestingly, and illustrating the crucial importance of regulation for financial intermediation, is that there are some authors who suggest that unregulated finance or ‘free banking’ would be highly desirable, as it would be stable and inflation-free. Proponents of this view are, among others, White, 1984; Selgin, 1987; Dowd, 1989. Modern Theories of Financial Intermediation19 in case of the functioning of the intermediaries. The studies that appear in most academic journals analyze situations and conditions under which banks or other intermediaries are making markets less imperfect as well as the impediments to their optimal functioning.Perfect markets are the benchmarks and the intermediating parties are analyzed and judged from the viewpoint of their contribution to an optimal allocation of savings, that means to market perfection. Ideally, financial intermediaries should not be there and, being there, they at best alleviate market imperfections as long as the real market parties have no perfect information. On the other hand, they maintain market imperfections as long as they do not completely eliminate informational asymmetries, and even increase market imperfections when their risk aversion creates credit crunches.So, there appears not to be a heroic role for intermediaries at all! But if this is really true, why are these weird creatures still in business, even despite the fierce competition amongst themselves? Are they truly dinosaurs, completely unaware of the extinction they will face in the very near future? This seems highly unlikely. Section 3 showed and argued that the financial intermediaries are alive and kicking. They have a crucial and even increasing role within the real-world economy. They increasingly are linked up in all kinds of economic transactions and processes.Therefore, the next section is a critical assessment of the modern theory of financial intermediation in the face of the real-world behavior and impact of financial institutions and markets. 5. Critical Assessment Two issues are of key importance. The first is about why we demand banks and other kinds of financial intermediaries. The answer to this question, in our opinion, is risk management rather than informational asymmetries or transaction costs. Economies of scale and scope as well as the delegation of the screening and monitoring function especially apply to dealing with risk itself, rather than only with information.The second issue that matters is why banks and other financial institutions are willing and able to tak e on the risks that are inevitably involved in their activity. In this respect, it is important to note that financial intermediaries are able to create comparative advantages with respect to information acquisition and processing in relation to their sheer size in relation to the customer whereby they are able to manage risk more efficiently. We suggest Schumpeter’s view of entrepreneurs as innovators and Merton’s functional perspective of financial intermediaries in tandem are very helpful in this respect.One should question whether the existence of financial intermediaries and the structural development of financial intermediation can be fully explained by a theoretical framework based on the neo-classical concept of perfect competition. The mainstream theory of financial intermediation, as it has been developed in the past few decades, has – without any doubt – provided numerous valuable insights into the behavior of banks and other intermediaries and their managers in the financial markets under a broad variety of perceived and observed circumstances.For example, the â€Å"agency revolution†, unleashed by Jensen and Meckling (1976), focussed on principal-agent relation asymmetries. Contracts and conflicts of interest on all levels inside and outside the firm in a world full of information asymmetries became the central theme in the analysis of financial decisions. Important aspects of financial decisions, which previously went unnoticed in the neo- classical theory, could be studied in this approach, and a â€Å"black box† of financial decision making was opened. But the power of the agency heory is also her weakness: it mainly explains ad hoc situations; new models based on different combinations of assumptions continuously extend it. 4 In nearly all 4 To this extent, one can draw a striking parallel with the traditional Newtonian view of the natural world. The planetary orbits round the Sun can be explained very well with the Newtonian laws of gravitation and force. Apparent anomalies in the orbital movement of Neptune turned out to be caused by the influence of an hitherto unknown planet (Pluto).Its (predicted) astronomical 21 22Critical Assessment financial decisions, information differences and, as a consequence, conflicts of interest, play a role. Focussed on these aspects, the agency theory is capable of investigating nearly every contingency in the interaction of economic agents deviating from what they would have done in a market with perfect foresight and equal incentives for all agents. However, the applications from agency theory have mainly anecdotal value; they are tested in a multitude of specific cases.But the theory fails to evolve into a general and coherent explanation of what is the basic function of financial intermediaries in the markets and the economy as a whole. Various researchers interested in real world financial phenomena have pointed out that banks in particular do make a difference. They come up with empirical evidence that banks are special. For example, Fama (1985) and James (1987) analyze the incidence of the implicit tax due to reserve requirements. Both conclude that bank loans are special, as bank CDs have not been eliminated by non-bank alternatives that bear no reserve requirements.Mikkelson and Partch (1986) and James (1987) look at the abnormal returns associated with announcements of different types of security offerings and find a positive response to bank loans. Lummer and McConnel (1989) and Best and Zhang (1993) have confirmed these results. Slovin et al. (1993) look into the adverse effect on the borrower in case a borrower’s bank fails. They find Continental Illinois borrowers incur significant negative abnormal returns during the bank’s impending failure. Gibson (1995) finds similar results when studying the effects of the health of Japanese banks on borrowers.Gilson et al. (1990) find that the likelihood o f a successful debt restructuring by a firm in distress is positively related to the extent of that firm’s reliance on bank borrowing. James (1996) finds that the higher the proportion of total debt held by the bank, the higher the likelihood the bank debt will be impaired, and so the higher the likelihood that it participates in the restructuring. Hoshi et al. (1991) for Japan and Fohlin (1998) and Gorton and Schmid (1999) for Germany also find that in these countries, banks provide valuable services that cannot be replicated in capital markets.Current intermediation theory treats such observations often as an anomaly. But, in our perspective, it relates rather to the insufficient explanatory power of the current theory of financial intermediation. observation was regarded as an even greater victory for Newtonian theory. However, it took Einstein and Bohr to reveal that this theory is only a limit case as it is completely unable to deal with the behavior of microparticles (s ee Couper and Henbest, 1985; Ferris, 1988; Hawking, 1988). Critical Assessment23The basic reason for the insufficient explanatory power of the present intermediation theory has, in our opinion, to be sought in the paradigm of asymmetrical information. Markets are imperfect, according to this paradigm, because the ultimate parties who operate in the markets have insufficient information to conclude a transaction by themselves. Financial intermediaries position themselves as agents (â€Å"middlemen†) between savers and investors, alleviating information asymmetries against transaction costs to a level where total savings are absorbed by real investments at equilibrium real interest rates.But in the real world, financial intermediaries do not consider themselves agents who intermediate between savers and investors by procuring information on investors to savers and by selecting and monitoring investors on behalf of savers. That is not their job. They deal in money and in risk, n ot in information per se. Information production predominantly is a means to the end of risk management. In the real world, borrowers, lenders, savers, investors and financial supervisors look at them in the same way, i. . risk managers instead of information producers. Financial intermediaries deal in financial services, created by themselves, mostly for their own account, via their balance sheet, so for their own risk. They attract savings from the saver and lend it to the investor, adding value by meeting the specific needs of savers and investors at prices that equilibrate the supply and demand of money. This is a creative process, which cannot be characterized by the reduction of information asymmetries.In the intermediation process the financial intermediary transforms savings, given the preferences of the saver with respect to liquidity and risk, into investments according to the needs and the risk profile of the investor. It might be clear that for these reasons the views of Bryant (1980) and of Diamond and Dybvig (1983) on the bank as a coalition of depositors, of Akerlof (1970) and Leland and Pyle (1977) on the bank as an information sharing coalition, and of Diamond (1984) on the bank as delegated (†¦ monitor, do not reflect at all the view of bankers on their own role. Nor does it reflect the way in which society experiences their existence. Even with perfect information, the time and risk preferences of savers and investors fail to be matched completely by the price (interest rate) mechanism: there are (too many) missing markets. It is the financial intermediary that somehow has to make do with these missing links. The financial intermediary manages risks in order to allow for the activities of other types of households within the economy.One would expect that the theory of the firm would pay ample attention to the driving forces behind entrepreneurial activity and could thus explain in more general terms the existence of financial intermedia tion as an entrepreneurial 24Critical Assessment activity. However, this is not the focus of that theory. The theory of the firm is preoccupied with the functioning of the corporate enterprise in the context of market structures and competition processes.In the wake of Coase (1937), the corporate enterprise is part of the market structure and can even be considered as an alternative for the market. This view laid the foundation for the transaction cost theory (see Williamson, 1988), for the agency theory (Jensen and Meckling, 1976), and for the theory of asymmetric information (see Stiglitz and Weiss, 1981 and 1983). Essential in the approaches of these theories is that the corporate enterprise is not treated as a â€Å"black box†, a uniform entity, as was the case in the traditional micro-economic theory of the firm.It is regarded as a coalition of interests operating as a market by itself and optimizing the opposing and often conflicting interests of different stakeholders (clients, personnel, financiers, management, public authorities, non-governmental organizations). The rationale of the corporate enterprise is that it creates goods and services, which cannot be produced, or only at a higher price, by consumers themselves. This exclusive function justifies transaction costs, which are seen as a form of market imperfection.The mainstream theory of the firm evolved under the paradigm of the agency theory and the transaction costs theory as a theory of economic organization rather than as a theory of entrepreneurship. A separate line of thinking in the theory of the firm is the dynamic market approach of Schumpeter (1912), who stressed the essential function of entrepreneurs as innovators, creating new products and new distribution methods in order to gain competitive advantage in constantly developing and changing markets.In this approach, markets and enterprises are in a continuous process of â€Å"creative destruction† and the entrepreneurial function is pre-eminently dynamic. Basic inventions are more or less exogenous to the economic system; their supply is perhaps influenced by market demand in some way, but their genesis lies outside the existing market structure. Entrepreneurs seize upon these basic inventions and transform them into economic innovations. The successful innovators reap large short-term profits, which are soon bid away by imitators.The effect of the innovations is to disequilibrate and to alter the existing market structure, until the process eventually settles down in wait for the next (wave of) innovation. The result is a punctuated pattern of economic development that is perceived as a series of business cycles. Financial intermediaries, the ones that mobilize savings, allocate capital, manage risk, ease transactions, and monitor firms, are essential for economic growth and development. That is what Joseph Schumpeter argued early in this century.Now there is evidence to support Schumpeter’ s view: financial services promote development (see King and Critical Assessment25 Levine, 1993; Benhabib and Spiegel, 2000; Arestis et al. , 2001; Wachtel, 2001). The conceptual link runs as follows: Intermediaries can promote growth by increasing the fraction of resources society saves and/or by improving the ways in which society allocates savings. Consider investments in firms. There are large research, legal, and organizational costs associated with such investment.These costs can include evaluating the firm, coordinating financing for the firm if more than one investor is involved, and monitoring managers. The costs might be prohibitive for any single investor, but an intermediary could perform these tasks for a group of investors and lower the costs per investor. So, by researching many firms and by allocating credit to the best ones, intermediaries can improve the allocation of society’s resources. Intermediaries can also diversify risks and exploit economies of scale .For example, a firm may want to fund a large project with high expected returns, but the investment may require a large lump-sum capital outlay. An individual investor may have neither the resources to finance the entire project nor the desire to devote a disproportionate part of savings to a single investment. Thus profitable opportunities can go unexploited without intermediaries to mobilize and allocate savings. Intermediaries do much more than passively decide whether to fund projects. They can initiate the creation and transformation of firms’ activities.Intermediaries also provide payment, settlement, clearing and netting services. Modern economies, replete with complex interactions, require secure mechanisms to settle transactions. Without these services, many activities would be impossible, and there would be less scope for specialization, with a corresponding loss in efficiency. In addition to improving resource allocation, financial intermediaries stimulate individ uals to save more efficiently by offering attractive instruments that combine attributes of depositing, investing and insuring.The securities most useful to entrepreneurs – equities, bonds, bills of exchange – may not have the exact liquidity, security, and risk characteristics savers desire. By offering attractive financial instruments to savers – deposits, insurance policies, mutual funds, and, especially, combinations thereof – intermediaries determine the fraction of resources that individuals save. Intermediaries affect both the quantity and the quality of society’s output devoted to productive activities. Intermediaries also tailor financial instruments to the needs of firms.Thus firms can issue, and savers can hold, financial instruments more attractive to their needs than if intermediaries did not exist. Innovations can also spur the development of financial services. Improvements in computers and communications have triggered financial inn ovations over the past 20 years. Perhaps, more important for developing countries, growth can increase the demand for financial services, sparking their adoption. 26Critical Assessment In translating these concepts to the world of financial intermediation, one ends up at the so-called functional perspective (see Merton, 1995a).The functions performed by the financial intermediaries are providing a transactions and payments system, a mechanism for the pooling of funds to undertake projects, ways and means to manage uncertainty and to control risk and provide price information. The key functions remain the same, the way they are conducted varies over time. This looks quite similar to what Bhattacharya and Thakor (1993) regard as the qualitative asset transformation operations of financial intermediaries, resulting from informational asymmetries.However, in our perspective, it is not a set of operations per se but the function of the intermediaries that gives way to their presence in t he real world. Of course, we are well aware of the fact that in the real-world the everyday performance of these different functions can be experienced by clients as – to quote Boot (2000) – †an annoying set of transactions†. The key functions of financial intermediaries are fairly stable over time. But the agents that are able and willing to perform them are not necessarily so. And neither are the focus and the instruments of the financial supervisors.An insurance company in 2000 is quite dissimilar in its products and distribution channels from one in 1990 or 1960. And a bank in Germany is quite different from one in the UK. Very different financial institutions and also very different financial services can be developed to provide the de facto function. Furthermore, we have witnessed waves of financial innovations, consider swaps, options, futures, warrants, asset backed securities, MTNs, NOW accounts, LBOs, MBOs and MBIs, ATMs, EFTPOS, and the distribut ion revolution leading to e-finance (e. . see Finnerty, 1992; Claessens et al. , 2000; Allen et al. , 2002). From this, financial institutions and markets increasingly are in part complementary and in part substitutes in providing the financial functions (see also Gorton and Pennacchi, 1992; Levine, 1997). Merton (1995a) suggests a path of the development of financial functions. Instead of a secular trend, away from intermediaries towards markets, he acknowledges a much more cyclical trend, moving back and forth between the two (see also Rajan and Zingales, 2000).Merton argues that although many financial products tend to move secularly from intermediaries to markets, the providers of a given function (i. e. the financial intermediaries themselves) tend to oscillate according to the product-migration and development cycle. Some products also move in the opposite direction, for example the mutual fund industry changed the composition of the portfolios of US households substantially, that is, from direct held stock to indirect investments via mutual funds (Barth et al. , 1997). In our view, this mutual Critical Assessment27 und revolution in the US – and elsewhere – is a typical example of the increasing role for intermediated finance in the modern economy. Thus, in our opinion, one should view the financial intermediaries from an evolutionary perspective. They perform a crucial economic function in all times and in all places. However, the form they have changes with time and place. Maybe once they were giants, dinosaurs so to say, in the US. Nowadays, they are no longer that powerful but they did not lose their key function, their economic niche.Instead, they evolved into much smaller and less visible types of business, just like the dinosaurs evolved into the much smaller omnipresent birds. Note that most of the theoretical and empirical literature actually refers to banks (as a particular form of financial intermediary) rather than to all finan cial institutions conducting financial intermediation services. However, the bank of the 21st century completely differs from the bank that operated in most of the 20th century. Both its on- and off-balance sheet activities show a qualitatively different composition.That is, away from purely interest related lending and borrowing business towards fee and provision based insurance-investment-advice-management business. At the same time, the traditional insurance, investment and pension funds enter the world of lending and financing. As such, financial institutions tend to become both more similar and more complex organisations. Thus, it appears that the traditional banking theories relate to the creation of loans and deposits by banks, whereas this increasingly becomes a smaller part of their business.This is not only because of the changing composition of their income structure (not only interest-related income but also fee-based income). Also it is the case because of the blurring borders between the operations of the different kinds of financial intermediaries. Therefore, we argue first that the loan and the deposit only are a means to an end – which is acknowledged both by the bank and the customer – and that the bank and the non-bank financial intermediary increasingly develop qualitatively different (financial) instruments to manage risks.Questioning whether informational asymmetry is the principal explanatory variable of the financial intermediation process – what we do – does not imply denial of the pivotal role information plays in the financial intermediation process. On the contrary, under the strong influence of modern communication technologies and of the worldwide liberalization of financial services, the character of the financial intermediation process is rapidly changing. This causes a – until now only relative – decrease in traditional 28Critical Assessment forms of financial intermediation, namely in on-balance sheet banking.But the counterpart of this process – the increasing role of the capital markets where savers and investors deal in marketable securities thanks to world wide real time information – would be completely unthinkable without the growing and innovating role of financial intermediaries (like investment banks, securities brokers, institutional investors, finance companies, investment funds, mergers and acquisition consultants, rating agencies, etc. ). They facilitate the entrepreneurial process, provide bridge finance and invent new financial instruments in order to bridge different risk preferences of market parties by means of derivatives.It would be a misconception to interpret the relatively declining role of traditional banks, from the perspective of the financial sector as a whole, as a general process of disintermediation. To the contrary, the increasing number of different types of intermediaries in the financial markets and their increasing importance as financial innovators point to a swelling process of intermediation. Banks reconfirm their positions as engineers and facilitators of capital market transactions.The result is a secular upward trend in the ratio of financial assets to real assets in all economies from the 1960s onwards (see Table 3). It appears that informational asymmetries are not well-integrated into a dynamic approach of the development of financial intermedation and innovation. Well-considered, information, and the ICT revolution, plays a paradoxical role in this process. The ICT revolution certainly has an excluding effect on intermediary functions in that it bridges informational gaps between savers and investors and facilitates them to deal directly in open markets.This function of ICT promotes the exchange of generally tradable, thus uniform products, and leads to the commoditizing of financial assets. But the ICT revolution provokes still another, and essentially just as revolutionary, effect , namely the customizing of financial products and services. Modern network systems and product software foster the development of ever more sophisticated, specific, finance and investment products, often embodying option-like structures on both contracting parties which are developed in specific deals, thus â€Å"tailor made†, and which are not tradable in open markets.Examples are specific financing and investment schemes (tax driven private equity deals), energy finance and transport finance projects, etc. They give competitive advantages to both contracting parties, who often are opposed to public knowledge of the specifics of the deal (especially when tax aspects are involved). So, general trading of these contracts is normally impossible and, above all, not aimed at. (But imitation after a certain time lag can seldom be prevented! Informational data (on stock prices, interest and exchange rates, commodity and energy prices, Critical Assessment29 macroeconomic data, etc. ) are always a key ingredient of these investment products and project finance constructions. In this respect, information is attracting a pivotal role in the intermediation function because it is mostly the intermediation industry, not the ultimate contract parties that develop these new products and services. The function of information in this process, however, differs widely from that in the present intermediation

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