If there were full information about the creditworthiness of enterprises and other economic agents, banks would probably not exist. All finance would be 'direct finance' in the sense that lenders would finance enterprises and households directly, without the need for banks or other financial intermediaries. 1 Likewise, there would probably be no need for money since borrowing and financing would involve transfers of assets between portfolios of wealth.
Moreover, the vision of a world without banks may be contemplated in the context of the full consequences of the ongoing communications and information technology (CIT) revolution. Electronic funds transfer is already replacing cheques and giro-based transactions; it is anticipated that 'electronic wallets' will replace wallets and purses containing bank notes and coins. Although it is normally assumed that 'direct finance' in the form of bonds and equity (shares) needs stock markets and brokers, Electronic Communication Networks (ECNs) are already taking business from traditionally organised stock exchanges. Young and Theys (1999) forecast that stock exchanges will be the early victims of the internet revolution. Direct trading by individual investors on the internet is already undermining the role of traditional broking houses. It is thus possible that 'direct finance' could ultimately mean just that, lending direct to borrowers and cutting out both banks and brokers.
Banks and organised capital markets currently play an important role in enterprise financing because of lack of full information on the credit standings of borrowers. 2 In this context, banks fill the vacuum created by market failure. Borrowers normally have more information about their credit standing than lenders and consequently there is asymmetry of information (see, for example, Brock and Evans, 1997). In the real world of information asymmetry, which is most acute in developing countries, banks not only exist but dominate the financial system (Bhatt, 1994). 3 As banks gain expertise in lending, essentially appraising credit risks, they can develop well-diversified loan-asset portfolios to underwrite their commitment to repay deposits, on demand, and at their full nominal value. In the process of developing such portfolios in pursuit of profit they should allocate capital to its most efficient uses and ensure that it continues