Customers and Investors: A Framework for Understanding Financial Institutions

Robert Merton and Richard Thakor

No 21258, NBER Working Papers from National Bureau of Economic Research, Inc

Abstract: Financial institutions have both investors and customers. Investors, such as those who invest in stocks and bonds or private/public-sector guarantors of institutions, expect an appropriate risk-adjusted return in exchange for the financing and risk-bearing that they provide. Customers of a financial intermediary, in contrast, provide financing in exchange for a specific set of services, and do not want the fulfillment of these services to be contingent on the credit risk of the intermediary, even when they are not small, uninformed agents lacking in sophistication. This paper develops a framework that defines the roles of customers and investors in intermediaries, and uses the framework to provide an economic foundation for the aversion to intermediary credit risk on the part of its customers. This customer-investor nexus has implications for a host of issues related to how contracts between financial intermediaries and their customers are structured and how risks are shared between them, as well as the consequences of (unanticipated) deviations from the ex ante efficient contractual arrangement for institutional design, regulatory practices, and financial crises. Moreover, customers and investors are often intertwined in practice, and so this intertwining provides insights into the adoption of “too-big-to-fail” policies and bailouts by regulators in general.

JEL-codes: D81 D83 G01 G20 G21 G23 G28 H12 H81 (search for similar items in EconPapers)
Date: 2015-06
New Economics Papers: this item is included in nep-ban
Note: EFG LE POL
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (4)

Published as Robert C. Merton & Richard T. Thakor, 2018. "Customers and Investors: A Framework for Understanding the Evolution of Financial Institutions," Journal of Financial Intermediation, .

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