24: Financial System and Economic Growth

Question 1

role of the financial system

Answer 1

channelling funds from households, businesses and governments with surplus funds to households, businesses and governments with a shortage of funds

Question 2

direct finance

Answer 2

channels funds directly through the financial market

financial markets
- exchanges
- investment banking

financial instruments/securities
- equities
- bonds

Question 3

indirect finance

Answer 3

channels funds through a financial intermediary

Question 4

information challenges

Answer 4

financial intermediaries exist because of this

asymmetric information

free-rider problems

Question 5

why does asymmetric information lead to a less efficient allocation of funds?

Answer 5

adverse selection

moral hazard

Question 6

how do financial intermediaries solve asymmetric information problems?

Answer 6

issuing private loans to reduce free-rider problems

using credit standards to avoid adverse selection

imposing loan covenants to prevent moral hazard

Question 7

role of the government

Answer 7

regulation

provision of a safety net

Question 8

governments promoting transparency

Answer 8

disclosure of financial information from public firms

adherence to generally acceptable accounting standards

Question 9

prudential regulation

Answer 9

rules the government sets to prevent banks from taking on too much risk

Question 10

prudential supervision

Answer 10

activities the government engaged in to enforce prudential regulation

Question 11

relationship between financial development and economic growth

Answer 11

increases in private credit lead to a more efficient allocation of credit, an increase in investment in more productive assets and faster economic growth