A functional Perspective of Financial Systems and Financial Intermediation
Charles G. Inyangete (Professor of Finance and Director of the collaborative MSc finance programe between The Institute of Finance Management (IFM) Tanzania and the University of Strathclyde, Glasgow UK)
Download Article | Published On 01/07/1997

Abstract

Questions concerning the design of a completely new financial system for a country are no longer simply of academic interest. Increasingly policy makers around the world are embarked on fundamental changes to financial systems of their countries. The central theme of this paper is the focus on financial functions instead of financial institutions as the unit of analysis. The key role of any financial system is to facilitate the allocation and utilization of economic resources in a changing environment. Alternative approaches to the analysis of financial intermediaries are: first to accept as given the existing institutional structure of financial intermediaries and to perceive the public policy objectives as one of enabling the institutions to survive and prosper in their existing formĀ­ an institutional approach; the second is to accept as given the economic functions performed by financial intermediaries and to seek ways of organizing the best institutional structure for performing those functions- a functional approach. A functional approach does not necessarily require preserving existing institutions. This paper argues that the second approach is more enduring and is preferred. The theories of financial innovation in the provision of intermediati n services are directed towards achieving greater efficiency. The paper further contends that adopting functional perspective as opposed to a more tightly-defined institutional approach should result in a more flexible, better co-ordinated, and by implication more effective system of supervision. In an international context adopting a functional perspective makes for greater adaptability of differences in institutional structures across countries to a global setting for the financial system. Innovation in financial intermediation is largely driven by inter alia the institutional and regulatory environment. The success .of any financial intermediary hinges on its ability to control both the actual and perceived default risk of its liabilities held by customers. As with well established markets increased customer demand for service and increased complexity of products will make this an issue for future focus in Tanzania and Africa in general. Financial intermediary function will be widened to include the management of its counter-party credit risk exposure, in addition to the more familiar working capital requirements. In examining the theories of intermediation and functions of intermediaries the paper provides an adapted econometric model for analyzing the credit standing (rating) of opaque financial institutions. Although the econometric model is incomplete in dealing with the problems of the real-world, it offers a robust approach to evaluating the credit-risk of African intermediaries where the public as in elsewhere are concerned about the safety and soundness of individual financial institutions. The illustrations given in section 4 clearly do not provide a fully specified model of the agency cost structure faced by financial intermediaries. But perhaps it will serve to focus attention and stimulate further research on these issues of immense importance to intermediaries involved in credit-sensitization activities.

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