If the Market is Perfect, Would the Banks be Extinct?
CURTIN UNIVERSITY OF TECHNOLOGY
In recent years, many of the observers believe that the financial market will be perfect due to the new and creative proposition to a variation of financial instrument and the elimination of government intervention. According to the Modigliani and Miller theory (MM theorem), in the assumption where market is perfect, the financial institutions have no major functions. (Mehta and Fung 2004, 15)
The perfect market is a market where the securities market participant can:
No one is a price maker, everyone is a price taker
All market participants can issue securities under the same terms
Frictionless market (There are no taxes or transaction cost, information costs, and no insolvency costs
Absence of scale and scope economies
All financial titles are homogeneous, divisible and tradable
All market parties can receive information easily for the future value of traded financial instrument
(Scholtens and Wensveen 2003, 9)
Under the MM theory, there is no relationship between the firm value and the way the firm is being financed.
It means that, in the situation where the market is perfect, the firm can finance their capital in any ways they want, for example by selling debts or issuing stock. As a result, the role of bank which is to help the firm in financing activities will become superfluous. (Mehta and Fung 2004, 15)
Therefore, this report will examine the effect of the perfect market to the role of financial institutions from different view of author. However, before the effect will be discussed, it is important to analyze the possibility to create the perfect market in the real world. It is possible to create perfect market?
This report contains 4 sections. The first section is the introduction which talks...