Essays on frictions in financial institutions

Abstract

In this thesis, I explore the consequences of frictions in financial intermediation. I theoretically analyse two financial contracts commonly found in the modern shadow banking system-rehypothecation and securitisation. Rehypothecation is the direct repledging of the collateral received in a debt contract by the intermediate lender, while securitisation is the use of the debt contract itself as collateral. I show that rehypothecation enables more efficient reuse of the collateral by the intermediate lender. I emphasise the role of the limited pledgeability of the intermediary in differentiating between the two contracts. In what has significant implications for monetary policy, I also show that open market operations undertaken with the intention of increasing liquidity and investment will take away collateral from the rehypothecation chain and be counterproductive to investment down the chain. I also examine the possibility of distortions created by large global financial institutions on emerging financial markets. In the context of India, I find that prices of firms that receive foreign institutional investor flows are not differentially affected relative to the firms that don't.