Question

Advantages and disadvantages of depository institutions

Answer 1

Allowing for the absence of deposits from the funding mix, all lending institutions consider
essentially the same set of options for managing interest rate risk:
Manipulation of GAP,
use
of variable-rate financial instruments, sale or securitisation of assets, and off-balance-sheet
hedging.
Larger institutions
have
wider access to these options
than smaller institutions.
Depository
institutions
enjoy
a
number of
liquidity
“fixes”
not
available
to
finance
companies—
a lender of last resort,
insurance to the providers of most of the loanable funds,
and cooperative liquidity management resources such as Fed Funds and correspondent
banking.
On the other hand,
liquidity
is
less of an issue for finance companies
because they
both borrow and lend at fixed maturities and do not market liquidity as a financial service to
their creditors.
It is relatively easy for larger finance companies to sell or securitise assets to
raise liquidity.
Credit risk
is an
unsystematic risk
which can be
managed through
underwriting standards and portfolio diversification.
Depository
institutions receive a lot of
“help” from regulators
in managing credit risk, and cannot assume too much of it without
predictable and significant consequences.
Finance companies
are
left alone
to make their
own
philosophical
choices
about
credit
risk
,
subject
to
such
policing
as
creditors,
shareholders, and the markets may care to do.