The Economic History of Banking

Authored by: Richard S. Grossman

Routledge Handbook of Modern Economic History

Print publication date:  December  2012
Online publication date:  January  2013

Print ISBN: 9780415677042
eBook ISBN: 9780203075616
Adobe ISBN: 9781135121211


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Among the most important functions of a financial system is intermediation: channeling the aggregate savings of an economy toward productive use. 1 In the absence of intermediators, individuals, firms, and governments in need of finance and savers with surplus funds seeking investment opportunities would have to find each other and negotiate detailed contracts. These contracts would have to specify whether the funds are be loaned or to purchase a share of the enterprise. If loaned, the contract must stipulate the term and interest rate of the loan, as well as the amount and quality of collateral to be pledged as security. If the funds purchase an ownership share, the contract must stipulate the fraction of the profits and seats on the board of directors the new investor will be entitled to and, if the enterprise fails, how much liability the shareholder will bear. Without financial intermediators, negotiating such arrangements would be so costly and time consuming that many worthwhile projects would go unfunded. The consequences for economic development would be severe.

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