What Is External Finance?

Financial externality is the external economic effect of private costs or private benefits spilling over to third parties in financial behavior. Its formation background is the development trend of global economic and financial integration and the formation of modern financial core roles in the economy. Both positive financial externalities and negative financial externalities mean the failure of financial market mechanisms, which is not conducive to the realization of Pareto efficiency of financial resources. Therefore, we should understand the nature of financial externalities, innovate financial systems, and improve financial functions. The construction and improvement of the economic system has practical and theoretical significance.

Financial externalities

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Financial externality is the external economic effect of private costs or private benefits spilling over to third parties in financial behavior. Its formation background is the development trend of global economic and financial integration and the formation of the core role of modern finance in the economy. Both positive financial externalities and negative financial externalities mean the failure of the financial market mechanism, which is not conducive to achieving the Pareto efficiency of financial resources. Therefore, we should understand the nature of financial externalities, innovate financial systems, and improve financial functions.

In today's world, finance has become the core of the modern economy, and its role in the economies of various countries is constantly expanding. The financial industry has strong externalities due to its special vulnerability, weak public goods nature, and weak effectiveness.

The fragility of the financial system has its own reasons. the first. The return on financial assets continues to decline; second, the highly leveraged business model of the financial industry often means equal amplification of returns or risks; third, the financial industry generally acts as a funding medium, and its assets and liabilities are difficult to match well. There are large potential risks; fourth, compared to other industries, the risks faced by the financial industry are more extensive, including credit risk, liquidity risk, exchange rate risk, interest rate risk, financial risk, financial crime risk, etc .; fifth The financial industry often has a higher debt ratio and a lower capital asset ratio.

As for financial services, it is a product provided to all the public. Basically, everyone can choose financial services. It is impossible to exclude one's consumption because of one's consumption, so it has weaker exclusivity. Simultaneously. Due to the economies of scale inherent in financial services, their competitiveness is also weak. Weak exclusive and competitive financial services have strong public goods attributes and can be called quasi-public goods.

According to a lot of research on the capital market by economists. Due to ubiquitous insider trading, it is very difficult to reach a strong and efficient market. Therefore, the financial industry and then the securities industry have strong externalities. When financial institutions and even the financial system are operating steadily, they can create good returns by themselves, at the same time, they can increase the input of social capital elements, provide low-cost funds for enterprises, improve the efficiency of capital utilization, provide convenient investment products for residents, Social wealth and other methods contribute to society, and therefore have a strong positive externality.

However, when financial institutions are closed or bankrupted due to high-risk activities or other reasons, it will have an adverse effect on the national economy and even lead to a financial crisis due to its important role and its extensive social influence, leading to a huge economy. Cost or opportunity cost, which generates great negative externalities. Such negative financial externalities often accumulate huge social costs, increase the tax burden of the people, disrupt normal economic development, shrink the economic aggregate, and reduce the living standards of the people, which is more harmful.

Regarding financial externalities, especially their negative externalities, due to their special status and influence, they are often resolved by the government, and the government's solution is generally to act as the lender of last resort and make up the financial industry with public financial funds Cave. As a result, the distribution of national wealth is unfair, while the offenders fail to pay the corresponding price and cannot establish corresponding restraint mechanisms. Therefore, an effective way to solve the externality of the financial industry is to "internalize" the externality through institutional arrangements, that is, to solve the internal problems of the industry, and the internal participants to establish a risk sharing mechanism.

In the securities industry, the Securities Investor Protection Fund is such a risk-sharing fund. It is jointly established by all the securities companies involved in securities trading. When a securities company is in crisis and it is difficult to survive, the protection fund pays the customers' claims of the securities company to avoid the risk of individual securities companies from being transmitted to the entire industry. At the same time, industry risks are digested internally, and compensation funds must be repaid by all securities companies after payment, which will promote the entire industry to continuously improve its risk control level.