Article by Periklis Glogas and Efthimia Chrysanthidou on 07 Feb 2013
Dr. Periklis Gogasis a frequent contributor to The Business Thinker magazine. He is an Assistant Professor of Economic Analysis and international Economics, Department of International Economics and Development, Democritus University of Thrace, Greece
Ms Efthimia Chrysanthidou is a PhD candidate in economics at the Democritus University of Thrace, Greece.
In the international financial system banking institutions played a core role in raising capital. Their central position was safe and unchallenged for many decades. This happened because banks can take advantage of both the economies of scale they create and their in-house expertise in risk assessment. These can reduce significantly both the financing cost and the adverse effects of asymmetric information as compared to direct financing. Moreover, the direct and one-to-one relation between the bank and the borrower provides the flexibility to adapt the financing and repayment schedule to the specific needs of the borrower. Therefore there is a state of complete transparency between the two parties.
Over the last three decades and as a result of the process of the deregulation in the financial system and the technological progress, the disintermediation was made possible: borrowers could more easily in terms of risk, cost and transparency raise the necessary capital directly from the lenders (individuals or corporations) in the capital market. The rating agencies played the role of the assessing the credit risk and thus the intermediation of a bank was not necessary. The advantage of the disintermediation is the reduction of the borrowing cost as the banking intermediary is absent. For large corporations with high creditworthiness the risk for the lender is minimized. As a result we observed a qualitative change in the borrower lender relationship: from the one-to-one direct transaction and negotiation to a relationship where the lender is now an anonymous crowd dispersed, heterogeneous and practically unknown to the borrower. There is now no flexibility on the financing terms and the lenders assume all the credit risk.