Einde inhoudsopgave
State aid to banks (IVOR nr. 109) 2018/3.2.1
3.2.1 Why banks are essential
mr. drs. R.E. van Lambalgen, datum 01-12-2017
- Datum
01-12-2017
- Auteur
mr. drs. R.E. van Lambalgen
- JCDI
JCDI:ADS590549:1
- Vakgebied(en)
Financieel recht / Europees financieel recht
Mededingingsrecht / EU-mededingingsrecht
Voetnoten
Voetnoten
See, for instance: Lyons 2009, p. 29.
In that regard, Schillig (2013, p. 754) argued that banks perform a quasi-utility function. About the crucial role of the banking sector, see also: Broekhuizen 2016, p. 50-51; Savvides & Antoniou 2009, p. 355-358; Lo Schiavo 2013, p. 151.
Direct financing and indirect financing are both forms of external financing. A firm can also use its own profits to finance new activities. This is called internal financing. See: Van Ewijk & Scholtens 1999, p. 38.
Van Ewijk & Scholtens 1999, p. 68-69.
Usually, the size of the deposits is smaller than the size of the loans. The reason is that most surplus units only have a limited amount of money to deposit, while deficit units often need a large amount of money. Think of an individual who wants to buy a house or a firm which wants to finance its business activities. Banks intermediate by ‘transforming’ several of those small deposits into one large loan.
Borrowers need capital to finance activities that may be risky, while lenders deposit their money because they do not want to take risk. Borrowing is risky, because deficit units have a risk of defaulting in their repayment. Because of intermediation, lenders no longer have a claim on the borrowers; instead, they have a claim on the bank that operates as intermediary. Claims on the bank (i.e. deposits) are usually less risky than claims on borrowers. Because of diversification, the default risk of banks is lower than the default risk of individual companies.
It should be noted that not all banking activities are performed by banks. Sometimes, other entities – such as money market funds, investment funds or securitisation vehicles – conduct banking activities. These entities are part of the so-called ‘shadow banking sector’. While there is no uniform definition, ‘shadow banking’ is usually defined as credit intermediation that takes place outside the regular banking system.
This raises the question why there is a need for financial intermediaries such as banks. The traditional answer to this question lies in the existence of market imperfections. In the economic literature, several arguments have been proposed in order to explain the need for financial intermediaries. Those arguments mainly rely on the following two market imperfections: transaction costs and information asymmetries. Banks – as intermediaries – can reduce the transaction costs, because they can exploit economies of scale and economies of scope.
Scholtens & Van Wensveen 2003, p. 28.
Van Ewijk & Scholtens 1999, p. 115.
Banks play an essential role in the economy. In the language of the Bank Recovery and Resolution Directive (which will be discussed in the next chapter), banks perform “critical functions”, such as safeguarding deposits, managing payments systems, providing loans and channelling capital for investment and innovation.
The banking sector can be described as the “lubricating oil”1 of the real economy: if the real economy were a machine, then the banking sector is a way to ensure that the economy operates smoothly. This illustrates the importance of the banking sector to the overall economy. By lending credit, banks are the facilitators of the real economy.2
This can be explained as follows. In economic terms: there are surplus units (households and firms with spare funds) and deficit units (households and firms in need of funds). There are essentially two ways to raise funds: direct financing and indirect financing.3 In case of direct financing, there is a direct relation between the lender and borrower: the lender has a claim on the borrower. One could think of securities such as shares or bonds. Financial markets play an important role here, because securities are traded on the financial markets. In case of indirect financing, the lender does not have a claim on the borrower, but on an intermediary, while the intermediary has a claim on the borrower.
Banks are financial intermediaries: by granting loans to deficit units (borrowers) and by taking deposits from surplus units (lenders), they bring together the demand and supply of capital. Borrowers and lenders usually have different preferences. As a result, the desired characteristics of the loans will be different from the desired characteristics of the deposits. Banks therefore have to fulfil a transformation function.4 The preferences of borrowers and lenders differ with respect to maturity, size and risk. As a consequence, three types of transformation can be distinguished: maturity transformation, size transformation5 and risk transformation.6 Of these three, maturity transformation is the most important. The importance of maturity transformation follows from the fact that deficit units (borrowers) usually want a loan for a longer period, while surplus units (lenders) want to be able to immediately withdraw money from their accounts. In other words: lenders and borrowers have different preferences with respect to the maturity. Banks intermediate between surplus units and deficit units by lending long and borrowing short. Loans can have a maturity of many years, while deposits are often withdrawable on demand.
The core function of banks is financial intermediation.7 Banks bring together supply and demand for capital. However, besides this indirect financing, firms can rely on direct financing, which takes place at the capital market. For instance, firms can issues shares or bonds. From this perspective, banks and the capital market compete.8 However, it should be pointed out that banks also have a role in direct financing, since they often assists firms that opt for direct financing. Banks are ‘facilitators of capital market transactions’.9 Banks perform functions such as underwriting and market making. In that regard, instead of making a profit from receiving interest on loans, banks make a profit from the fees that they charge for their services.10
To conclude, banks are the facilitators – the “lubricating oil” – of the real economy. This explains why the banking sector is so essential. Another specific feature of the banking sector is that banks are ‘special’; this will be explained in the following subsection.