Monday, June 8, 2009

financial disintermediation

The reverse of the financial intermediation process is financial disintermediation.Savers take funds out of deposit accounts and invest directly in,say,a bond issued by the U.S.government.In other words,rather than allowing the financial intermediary to use the saver,s deposited funds to purchase U.S.Treasury bonds,the saver does it directly.
Why disintermediation Occurs? Individuals remove their savings from financial institutions when the direct purchase of financial claims issued by households,corporations,and governments will bring a higher rate of return than a savings account in a financial intermediary.If,for example,a savings account in a thrift institution offers 5.25 percent interest,while securities issued by the U.S.government offer 12 percent interest,some savers will reduce the funds they maintain in thrifts or commercial bank saving deposits and increase their holdings of U.S.government securities.
Not surprisingly, the amount of disintermediation that occurs depends, in large part, on differences between interest rates offered by financial intermediaries and those offered by such ultimate borrowers as corporations and governments. the most rapid rate of disintermediation in the United States has occurred when nominal rates of interest have risen rapidly because of high rates of inflation (and therefore high anticipated future rates of inflation). this was possible because the regulations of the federal government prevented financial intermediaries from offering higher interest rates on normal savings-type accounts. other interest rates were unregulated and rose with the rate of inflation.
Conditions for disintermediation existed in 1969,1973,and 1974. During those periods, people predictably withdrew their savings deposits from thrifts and financial institutions and purchased financial assets directly;the rate of savings deposit growth fell dramatically during these episodes.
In 1975, as a reaction to the process of disintermediation, a new financial intermediary sprang up-money market mutual funds. these institutions were unregulated, and they offered interest rates on savings that were competitive with market interest rates. although this financial innovation helped to stem the tide of disintermediation, it didn't help the thrifts.
By the end of 1977, yields on U.S. Treasury bills (short-term bonds issued by the U.S. treasury) again rose above the maximum interest rates that commercial banks and thrift institution were legally permitted to pay on passbook savings deposits. In order to forestall another loss of savings deposits to the disintermediation process and to the mutual funds-an event that would have threatened the very existence of thrift institutions-federal regulators of depository institutions authorized a new category of 6-month time deposit called money market certificates. commercial banks, savings and loans. and mutual savings banks were permitted to offer these certificates after June 1,1978. This new liability and others have made the thrift institutions more competitive in the market for saving funds Of special importance in reversing the intra-intermediary movement of funds from thrift to money market mutual funds accounts is the money market deposits accounts, an instruments that competes directly with money market mutual funds.

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