Development of micro- and macroeconomic analysis of financial intermediation. Article 1. D. Diamond and Ph. Dybvig theories of banks' intermediary functions and development of microeconomic analysis of financial institutions

Abstract

The first of two articles which reveal the theoretical and practical significance of the researches awarded 2022 Sveriges Riksbank Prize in Economic Sciences. The author shows that the laureates laid the foundations of both the modern microeconomic theory of banks and financial institutions and the analysis of the role of financial intermediation in macroeconomic cycles. It is found that until the 1980s two powerful theoretical traditions dominated in the analysis of financial intermediation. The first tradition was to consider banks primarily as subjects of the money supply. It originates from the controversy between the quantitative theory of money and the real bills doctrine and culminates in the outstanding work by M. Friedman and A. Schwartz. The second tradition was a well-formalized neoclassical approach to the financial system. It was based on the efficient markets hypothesis, the Modigliani-Miller theorem, and the banking theory of E. Fama, where financial institutions are only a veil for real economic activities. It is shown that the growth of interest in the micro- and macroeconomic aspects of the financial sector activities in the late 1970s was due to the growth of its power due to the development of technologies and globalization, and due to the emergence of information economic theory which created a theoretical basis for the endogenous derivation of financial intermediaries that overcome market imperfections in ensuring the flow of funds between savers and borrowers. The article reveals the theoretical and practical importance of D. Diamond and Ph. Dybvig’s works, in which a bank endogenously arises as an optimal contract for solving important socio-economic problems of financing long-term projects with liquid deposits and of delegated monitoring of borrowers. The author emphasizes the importance of the scientists’ analysis and formalization of the incentives that determine the peculiarities of the intermediary role of banks and the nature of their services for financial regulation. It is shown that the model of delegated monitoring by D. Diamond not only demonstrates social benefits of specialization in monitoring, but also solves the problem of depositors' monitoring a bank as a monitor, revealing the incentives for the efficient implementation of borrowers monitoring by the bank: in conditions of diversification of borrowers, when their profits have an independent probability distribution, monitoring helps to avoid liquidation even in the event that part of the borrowers' projects are not successful. It is concluded that the formalization of the banks’ built-in vulnerability in the Diamond-Dybvig model, associated with their function of maturity transformation, and its overcoming by government institutional mechanisms, which, among other things, can distort the banks’ incentives, in effect substantiate the "symbiosis" of a state and banks in ensuring the latter’s stable functioning.