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Customers and Investors: A Framework for Understanding Financial Institutions

Author

Listed:
  • Robert C. Merton
  • Richard T. Thakor
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.

Suggested Citation

  • Robert C. Merton & Richard T. Thakor, 2015. "Customers and Investors: A Framework for Understanding Financial Institutions," NBER Working Papers 21258, National Bureau of Economic Research, Inc.
    • Handle: RePEc:nbr:nberwo:21258
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    References listed on IDEAS

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    Citations

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    Cited by:

    1. Kleimeier - Ros, Stefanie & Qi, Shusen & Sander, H., 2016. "Deposit Insurance in Times of Crises: Safe Haven or Regulatory Arbitrage? (RM/15/026-revised-)," Research Memorandum 026, Maastricht University, Graduate School of Business and Economics (GSBE).
    2. Viral V. Acharya & Hamid Mehran & Anjan V. Thakor, 2016. "Caught between Scylla and Charybdis? Regulating Bank Leverage When There Is Rent Seeking and Risk Shifting," The Review of Corporate Finance Studies, Society for Financial Studies, vol. 5(1), pages 36-75.
    3. Kleimeier, S. & Qi, S. & Sander, H., 2015. "Deposit insurance in times of crises : safe haven or regulatory arbitrage?," Research Memorandum 026, Maastricht University, Graduate School of Business and Economics (GSBE).
    4. Shy, Oz & Stenbacka, Rune, 2017. "An overlapping generations model of taxpayer bailouts of banks," Journal of Financial Stability, Elsevier, vol. 33(C), pages 71-80.

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    More about this item

    JEL classification:

    • D81 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Criteria for Decision-Making under Risk and Uncertainty
    • D83 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Search; Learning; Information and Knowledge; Communication; Belief; Unawareness
    • G01 - Financial Economics - - General - - - Financial Crises
    • G20 - Financial Economics - - Financial Institutions and Services - - - General
    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages
    • G23 - Financial Economics - - Financial Institutions and Services - - - Non-bank Financial Institutions; Financial Instruments; Institutional Investors
    • G28 - Financial Economics - - Financial Institutions and Services - - - Government Policy and Regulation
    • H12 - Public Economics - - Structure and Scope of Government - - - Crisis Management
    • H81 - Public Economics - - Miscellaneous Issues - - - Governmental Loans; Loan Guarantees; Credits; Grants; Bailouts

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