Financial System Architecture and Systematic Risk

This paper classifies different types of financial architecture in an economy with investment complementarities and imperfect information. Classification is done according to the roles played by direct and intermediated finance. When the return on assets traded in financial markets is more volatile than the returns offered by intermediaries, financial intermediation improves the coordination among investors, thereby enhancing efficiency and stabilizing the economy against macroeconomic shocks. However, the position of the intermediary is fragile since competition from financial markets can cause the collapse of the intermediation sector. Possible solutions to this problem are proposed.