Direct and Indirect Finance

1) Explain the difference between “indirect” finance and “direct” finance.

Indirect finance is a system in which financial institutions intermediate between households and firms lend to firms deposits collected from households, with credit risks

assumed by financial institutions. Direct finance is a system in which households and other retail investors assume direct risk and purchase prime securities issued by firms in the stock market.

2) Please refer to the table below. This table shows the changes in the households’ preference in portfolio selection between Japan and the US in a time-series comparison between as of March 1990 and March 2000. Describe the characteristics in each household’s preference, then point out a systemic problem in Japan’s financial structure if Japan is moving to the Anglo-American “securities-based” financial system. (See Suzuki 2009, pp.109-113)

Categories of financial assets

March 1990

March 2000

Japan

Currency and deposits

449 (48.5%)

748 (53.8%)

Bonds

69 (7.5%)

57 (4.1%)

Investment trusts

36 (3.9%)

35 (2.5%)

Shares and other equities

123 (13.3%)

117 (8.4%)

Insurance and pension reserves

191 (20.6%)

384 (27.6%)

Others

57 (6.2%)

49 (3.5%)

Total (Trillion yen)

926 (100%)

1,390 (100%)

U.S.

Currency and deposits

2.9 (19.4%)

3.5 (9.6%)

Bonds

1.9 (12.8%)

3.3 (9.2%)

Investment trusts

0.8 (5.6%)

4.2 (11.5%)

Shares and other equities

5.1 (33.7%)

13.4 (36.9%)

Insurance and pension reserves

3.9 (25.8%)

11.0 (30.5%)

Othres

0.4 (2.9%)

0.8 (2.3%)

Total (US$ Trillion)

15.0 (100%)

36.2 (100%)