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2.6. Financial intermediaries: intermediation functions

2.6.1. Introduction

This section describes the main intermediation functions of the financial intermediaries as identified in Box 1 in more detail, and a group of intermediaries. We cover:

• Monetary banking sector.

• Central bank.

• Private sector banks.

• Insurers.

• Retirement funds.

• Collective investment schemes.

• Alternative investments.

• Quasi-financial intermediaries.

2.6.2. Monetary banking sector

The group of institutions known as the monetary banking sector (MBS) or monetary banking institutions (MBIs) is mentioned separately because they are the intermediaries that play a substantial role in the financial system as follows:

• They are the custodians of most of the money stock of the country (i.e. private sector deposits with banks).

• They are the keepers of government's surplus balances.

• They are instrumental in providing loans to the government and corporate sectors.

• They are instrumental in purchasing the debt (= loans, but marketable) of the government and corporate sectors.

This group of monetary institutions differs from country to country, but it always includes the central bank and the private sector banks. Some countries have mutual banks, savings banks, co-operative banks, Post Office banks, rural banks, and so on.

Why this grouping? As indicated in the bullet points above, the members play a crucial role in money custody and loan / money creation. Therefore, they are used to calculate the money stock and the balance sheet causes of changes (BSCoC) in the money stock. All central banks on a monthly basis consolidate the statements of liabilities and assets (i.e. the balance sheets) of these intermediaries (in the process netting out interbank claims) in order to arrive at the monetary aggregate numbers and their statistical counterparts (the BSCoC). This is discussed further in a separate section.

2.6.3. Central bank

As is evident from the illustration shown earlier, the central bank intermediates between ultimate lenders (mainly the government in its capacity as government banker, and the household sector in its capacity as issuer of bank notes and coins) and the banks (i.e., their reserves required to be held for solvency and monetary policy purposes) on the one hand, and ultimate borrowers (as represented by its holdings of foreign exchange and domestic securities) and the private banking sector on the other. The last-mentioned would represent the central bank in its function as lender of last resort.

This flow (loans by the central bank to the banks) is illustrated in Figure 5 as (part of) the cb2b IBM (central bank-to-bank interbank market). This is the essence of monetary policy: loans to the banks (which is a permanent feature10) at the central bank's accommodation rate (KIR). These are the two variables that have a major bearing on money market interest rates and, therefore, on other interest rates and prices in the economy.

2.6.4. Private sector banks

The private sector banks intermediate between all the sectors that make up the ultimate lenders (i.e. the household, government, corporate and foreign sectors), and virtually all other financial institutions (in the form of deposits and loans), on the one hand, and all ultimate borrowers (in the form of loans, installment credit and leasing contracts, mortgage advances and the purchase of securities) on the other hand (including the foreign sector).

Banks also have an element of intermediation (on the asset side) with other financial intermediaries. For example, banks make loans to and/or hold the securities of other financial institutions such as the DFIs and the central bank (in the form of the reserve requirement).

 
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