EC223 Lecture Notes - Lecture 19: Adverse Selection, Credit Union, Moral Hazard
Document Summary
How financial innovation led to the growth of the shadow banking system. Financial innovation and the growth of the shadow banking system. Shadow banking system: bank lending replaced by lending via securities markets. A change in the financial environment will stimulate a search by financial institutions for innovations that are likely to be profitable: responses to change in demand conditions, responses to changes in supply conditions, avoidance of regulations. Responses to changes in demand conditions: interest rate volatility. Adjustable-rate mortgages: flexible interest rates keep profits high when rates rise, lower initial interest rates make them attractive to home buyers. Financial derivatives: ability to hedge interest rate risks, payoffs are linked to previously issues (i. e. derived from) securities. Responses to changes in supply conditions: information technology. Bank credit and debit cards: have been around since before wwii, cost per transaction was very high. Electronic banking: atm, home banking, virtual banking: offering an array of banking services exclusively on the internet.
