May 25, 1999

NOTE TO EDITORS

The Future of Financial Intermediation and Regulation: An Overview, the latest edition of the New York Fed’s Current Issues in Economics and Finance, is enclosed for your review.

Author Stephen G. Cecchetti, Executive Vice President and Director of Research, examines the services that financial intermediaries will provide in the next century and the form that those intermediaries are likely to take. Although he maintains that the restructuring of financial intermediation will not alter the fundamental rationale for regulation, he suggests that regulators will need to adapt to changes in the banking and financial system.

In looking at the financial services of the future, Cecchetti notes that financial intermediaries will continue to provide access to liquidity and to execute the transfer of assets between individuals. These intermediaries will also be involved in the packaging and selling of risk and the certification of asset quality. Advances in technology will transform the provision of credit, a key traditional function of banks, into a brokered activity.

Cecchetti envisions two possible forms for financial intermediaries in the next century: a "financial products supermarket" and an "all-in bank." Like a broker, the financial products supermarket would be a retail firm that handles asset allocation and payments and settlement services for individual and corporate customers. The all-in bank would combine the functions of funding and risk taking within a single organization. According to the author, the long-term trend will be toward financial supermarkets.

In the second half of the article, Cecchetti considers the implications of these changes for regulation:

  • The primary justifications for regulation--protecting consumers and reducing systemic risk--will still hold.
  • Although the centralized monitoring of financial firms will most likely remain the most efficient form of supervision, regulators will need to promote market discipline and allow a greater role for private sector monitoring.
  • Government guarantees--such as deposit insurance--will remain, but regulators will want to consider ways of reducing those guarantees and countering any encouragement they may give to irresponsible behavior on the part of insured institutions.
  • Given the eroding importance of national borders and the difficulties this erosion creates for authorities seeking to contain systemic risk within their jurisdictions, regulators should encourage efforts to coordinate supervisory standards across countries.

Contact: Douglas Tillett