Financial Disintermediation and International Banking

Introduction

As the development of global finance, along with the improvement of  market-oriented economy, and the loosening of supervision on financial market, financial disintermediation has become a globalization tendency. Disintermediation was originated from U.S., then expanded throughout the world, and brought great influence to developed countries like UK and Japan, as well as to developing countries like India and Brazil. Opportunities were created as well as challenges. The past researches have already analysed and researched disintermediation through various aspects: its connotation and causes, the measurement methods, its influences on specific country’s financial market and banking industry, and its impact on macro and micro economy also been discussed in the previous studies.

The analysis of this essay main focuses on discussion of disintermediation’s nature and causes, then try to make a conclusion of its impacts on international banking. Firstly this essay will begin with the description of the nature of disintermediation, and then go through the developing history of its definition, then will discuss causes of disintermediation from five aspects, finally its influences on banking industry will be discussed from three aspects.

Discussion 

The nature of disintermediation

Under normal circumstance, disintermediation means the transaction only occurs between the supply and requisitioning parties without a middleman. In the financial field, it represents the suppliers and demanders of funds conduct transactions without financial intermediaries. Disintermediation was first appeared in developed countries, the discussions around its nature are also based on situations of these countries’ banking sectors .

In 1960s, disintermediation actions were first observed in U.S. financial market. Interest rates of capital market kept increasing, which exceeded the prescribed upper limit of interest rate in Regulation Q, depositors withdrew cash from banks and invested their money in higher-return securities and bonds. D.D.Hester (1969) observed this phenomenon and invented the concept of disintermediation. Through the investigation of facts, Hester found out that the net revenue of commercial banks in U.S. reached the highest point in 1990, and then showed a downward trend in the following ten years, he defined this kind of phenomenon as ‘disintermediation’. Hester indicated that disintermediation could be expressed in two ways: on the one hand it could be seen as the decline of financial intermediaries’ assets growth rate, and on the other hand it could be seen as the situation that deposits from residents flew to stock market. Hamilton (1986) stated that disintermediation was the financing activities of demanders of funds which bypassed financial brokers like banks. Harmes (2001) indicated that when both sides of transaction trade with each other directly, that was disintermediation. Tan & Goh (2009) defined disintermediation as the activity that sectors with deficit problems bypassed banks and then raised financing through capital market directly, to satisfy its increasing demand of fund.

In the narrow sense, financial disintermediation refers to the situation that under the control of fixed deposit rates, the interest rate of currency market gradually exceeds the rate of deposit, so money flow from banks to currency market. The Regulation Q of U.S. reduced the cost of fund sources for commercial banks, but it also deprived banks of their fund sources――residents’ deposits flew to deposit facilities with higher interest rate. And in the broad sense, except the disintermediation of liabilities mentioned in the narrow sense, it also includes disintermediation of assets of commercial banks. That means demanders of funds raise capital by issuing shares, bonds or short-term commercial paper instead of borrowing money from financial intermediaries.

The causes of disintermediation

Researchers pointed out that on the basis of countries being investigated, there are five main causes of disintermediation:

Government direction

Roldós (2006) found out that the main reason for bank disintermediation in Canada in 1980s was the revision of the National Banking Act. In 1970s, enterprises in Canada relied largely on short-term loans to raise funds instead of issuing stocks because of the rise in inflation and the uncertainty of nominal interest rate. The Canadian government revised the National Banking Act in 1980, 1987, 1992 and 1997 respectively, the financial system of Canada had gradually shifted greater reliance on market, so enterprises increased proportion of direct financing and decreased that of indirect financing, and they accessed capital through issue corporate debt and commercial paper.  

Tan & Goh (2009) pointed out that in 1990s, bank disintermediation in Malaysia developed rapidly because the government’s financial policies gradually switched to market-oriented, public and private sectors tend to direct financing.

Transaction costs

In order to obtain more convenient and cheaper access to capital, companies chose to financing through capital market. D.D.Hester (1969) also recognised that compared to banks at that time, capital market could help companies to cut cost, the main superiority of capital market was that stocks and bonds had high degrees of freedom transform, so found raisers were able to save intermediary costs. P.F.Smith (1971) indicated that reasons for enterprises to financing in capital market were related to transaction costs in his research of competitions between banks and non-bank financial institutions.

Financial regulation

Interest rate control, exchange rate control and inflation force residents and companies steer away from financial institutions like banks which are regulated strictly, and buy financing products such as stocks, bonds and insurance. P.F.Smith (1971) stated that because the restriction of market interest rates, funds flow from banks to other financial institutions and capital market.

Financial innovations

There are some scholars indicate that the development of innovation abilities of financial institutions is an important reason for the appearance of disintermediation. Theodore (2000) pointed out that on the one hand, advances of science and technology enabled simplification of operation, this reduced people’s needs of banking; on the other hand, ATM, telephone banking, personal computer and internet have dispersed part of the traditional business of banks.