Caleb ~('\" Kush Project "8 Caleb ~(" is typing CHAPTER 2 The Role of Finanoal Markets and Financial Intermediaries 23 The $250,000 limit does mean that large depositors, including many corporations, are not fully insured and do stand to take losses should a bank fail. All commercial banks that are members of the Federal Reserve System must pur7 chase insurance from FDIC, and many state banking authorities also require that FDIC insurance be carried by their state nonmember banks. However, some state banking authorities do not require federal deposit insurance.Also foreign banks that are licensed to operate in the United States do not have to carry FDIC insurance Besides offering deposit insurance, FDIC has further increased public confidence in the banking system through its powers of bank examination By exercising this power to examine banks, FDIC, along with other regulatory agencies, has improved bank practices, The improved bank practices plus the deposit insurance have improved the quality of banking. However, the establishment of FDIC and other reg? ulatory agencies has not eliminated bank failures, for banks do fail. Such failures became common occurrences as a result of the financial crisis that started in 2008, During 2007, only three banks failed. However, the number of bank failures increased to 25 during 2008 and rose dramatically to 140 dure ing 2009. An additional 90 failures occurred during the first six months of 2010, then the rate of failures changed and only eight hanks failed in 2015 and six dur7 ing 2016. While most of these failures were small banks, losses were not sustained by the many individuals who deposited modest sums with the failed commercial banks. If necessary, such depositors received full reimbursement by FDIC. Thus, for most individuals, depositing funds in a commercial bank does not subject the funds to risk of loss. If a bank does fail, FDIC generally seeks to merge that bank into a stronger bank. The transfer of deposits saves FDIC from having to reimburse depositors. For exam? ple, when Washington Mutual failed, its assets were acquired by jI'Morgan Chase. Its depositors and customers became depositors and customers of the acquiring bank. There was no interruption of banking services, and depositors did not sustain losses, If, however, such a merger cannot be arranged, the failed bank may be liquidated, in which case the depositors receive reimbursement up to the legal limit. 2.8 Life Insurance Companies Life insurance companies also perform the role of a financial intermediary because they receive the funds of savers, create a claim on themselves, and lend the funds to borrowers Since other types of insurance companies do not perform this financial intermediary role, a distinction has to be made between them and life insurance com- panies. Other types of insurance, such as property and liability insurance, are exclue sively services that the individual buys. The price of the insurance is related to the cost of the product, just as the cost of any service, such as a movie or an electrician, is related to the cost of producing the service, Of course, the property and liability insurance companies invest the funds they receive from policyholdersi However, sup? pliers of other services will also use the funds they receive, In neither case is there a transfer of savings to borrowers. The feature that differentiates life insurance from other forms of insurance and makes life insurance companies financial intermediaries is that life insurance may provide more than insurance against premature death. Ordinary and universal life insurance policies and endowments contain two elements, the insurance and a save ings plant The policy's premiums cover both the cost of the insurance and the savings Copyiiqiii 2m 9 Ceiiqage Leaming All Rights Resewed May not be Copled. scanned or duplicated in whole or iii part ch 0272007203 Cupynglu ZUHCtlnggt Lem-imp, All mm. Rrunru MN ml hrulpinl. uumlnl ordnvlunlul ii. whulc M iii ...n 1mm rlmlnwm iigmc mint lhml pmy Lumtnl mm m wpputlmmthz {Hunk .iiwincmpimii, Elma-ml mm.\" mm m. my \"Wm.\" cumml anon. maul\" Hiram: mun learning mama cum tuning mm. m: ugh! immm \"unions rim-mi :n myiim irmmqmi \"won-ntimntmm ii Caleb ~('\" ' Kush Project "8 Caleb ~(" is typing... 24 PART1 Financial Institutions program. As long as the policy is in force, the policy accumulates cash value, which is the savings component of the policy. Many savers find such policies attractive because the periodic payments assure them of insurance plus a savings program. Others find them unattractive because the interest rate paid on the savings may be less than can be earned on alternative investments. Life insurance companies use the proceeds from the policies to acquire incomeaearning assets. While life insurance companies compete with commercial banks for granting loans, they serve different financial markets. Commercial banks stress shortiterm, liquid loans and are a primary source of shortiterm finance. Life insure ance companies, however, do not need to stress shortiterm liquidity. Mortality tables are scientifically constructed. A life insurance company can predict with accuracy the volume of death benefits that the company will have to pay and can construct a port? folio of longiterm assets that meets the forecast benefits. Since longiterm investments tend to earn higher interest rates than shortaterm debt, a life insurance company will seek to have a substantial amount of its funds in these more profitable investments. For example, the value of MetLife's longiterm bond portfolio is almost 27 times the size of its holdings of cash and other shortiterm securities. (The features of these various debt instruments are covered in Chapter 12.) 2.9 Pension Plans The role of a pension plan is to accumulate assets for workers so that they will have funds for retirement. Funds are periodically put in the pension plan by the saver, the employer, or both. The money deposited with the fund then is used to purchase incomeiearning assets. The saver's funds grow over time as additional contributions are paid into the pension plan, and the funds already in the plan earn income and appreciate in value. Many pension plans exist, but few of them really perform the function of finane cial intermediaries. Many pension plans do not invest or lend the money directly to borrowers. Instead they may purchase existing securities, such as the stock of IBM; that is, the pension plan participates in the secondary, not the primary, market for securities. For a pension plan to serve as a financial intermediary, it must pass the funds directly to a borrower or invest them directly in a firm. This distinction between pension plans may be illustrated by the pension plans used by many colleges and universities for their employees. Funds may be contributed by both the employer and the employee to the Teachers Insurance and Annuity Asso* ciation (TIAA) or to the College Retirement Equity Fund (CREF). The actual dollar amount of the contribution varies with the school and the employee's salary. The funds may be contributed to either plan or may be split between the two plans. CREF primarily purchases existing corporate stock. Money that flows into CREF does not go to the companies that issued the stock. Instead, the money goes to the seller of the stock, who may have purchased the shares many years ago. TIAA purchases an entirely different type of portfolio that stresses debt, especially morte gages. In this case funds are transferred from savers to borrowers, and the pen? sion plan is acting as a financial intermediary. It creates a claim on itself when it receives the savers' funds, and it receives a claim from borrowers when the funds are lent to finance purchases. The transfer of purchasing power from saver to borrower by an intermediary that creates claims on itself is the role of a financial intermedie ary. Hence, TIAA is an example of a pension plan that does serve as a financial intermediary. Copyiiqiii 2m 9 Cenqage Leaming All Rights Resewed May not be Copled. scanned or duplicated in whole or iii part ch 0272007203 Cupynglu mmmm: Lem-imp, All mm. Rtunrd MN ml hemmed. uunnnl ()rduvllmltil ii. whule M iii ...n 1mm elmlnwm Eighth. m lhml pmy Lumrnl um m wppnummmim {Bank "in alum-ml mm.\" mm in. my WWW cumml .imm maul\" Hiram: mun learning \"pg...\" cum tuning mm. is: ugh! immm alumna rim-mi :n myiim irmmqmi \"w