 Cool, we are recording. Hazakaz is MJ and in these videos, I'm going to be talking about various things about finance for the fellowship exam. So the previous one was around households and how they influence the economic environment. This time we're going to be talking about financial intermediaries. I always wonder if I'm spelling this stuff correctly. Financial intermediaries. Okay, remember these videos are unscripted. Unedited. It's me just giving my opinion, studying out loud. So don't take any of it as factual and feel free to challenge all of it in the comment section below. Like I said, it is going to be a lot of opinion-based and I am going to be quite skeptical when I approach the material. This just helps me to to think and to you know get the creative thinking juices flowing. Okay, financial intermediaries. What do I mean by financial intermediaries? I'm talking about banks, insurance companies. What else are financial intermediaries? Pension funds, investment banks, I mean collective investment vehicles. What else? We've got asset managers. Basically any middleman in the money the money thing. Asset management. So in the sense that you have businesses that use capital for productivity and you have investors who give up capital to fund that productivity intermediaries are the guys in between and my opinion at the moment is that they're actually we're not going to have these things in the future. These things are actually terrible with artificial intelligence and blockchain technology. We can have a future without these guys. And I think that's a good thing because these guys make lots and lots of money. Yes, they've added a lot of value to society in the past, but I think in the future we're not going to see them playing a very big role. But I'm talking about the far-distant future. You know, something like 2018, you know, far away. I'm joking. Maybe like 100 years from now. But so before that happens, we do need to to consider them. We do need to think about them and and what they do. So like I said, they are the middleman. So here we have them. Think of them as the middleman. And as a middleman, they make their money by charging a commission and they take a little fee here and there. So the more volume that happens in the financial markets, the more money they make as finance is growing, they're making more and more money. So they're actually very, very rich and they employ the majority of actresses and accountants, who are the two smartest people in the world. And actresses and accountants go there because they offer massive salaries because they need the smartest people to help them out with their various things. But essentially what they're doing is they are selling their own liabilities to raise funds that are used to purchase other liabilities. So they sell liabilities and they buy liabilities. Now, at first, that might sound a little bit confusing. So I'm just trying to... It's weird when you spell in capitals. Sorry, liabilities. My spelling is probably atrocious. So they buy and sell liabilities. Now remember, the best way I think of liabilities is to think of a coin on the one side. It's an asset on the other side. It's a liability. So an asset on my accounting record will be a liability on your accounting record. For example, let's say we go to the bank. We go to the bank and we deposit 100 rend. So we deposit 100 rend with the bank. Okay. That 100 rend to us is an asset. But to the bank, that 100 rend is a liability. So what they've done is by us giving 100 rend deposit to the bank, they have created this liability on their balance sheet. Yes, they've also created 100 rend cash reserves, but a liability has been created in the sense that they owe us 100 rend. They then take 90 rend of that and they lend it to a business to do productivity. So the bank then lends out 90 rend of our money to a business, which is now a liability for that business, but on their bank balance sheet, it will be an asset. And so it's important to understand the fundamental principles of accounting when doing finance because it's kind of like that's the lingo. It all comes down to, you know, assets, liabilities and all those various things. But what they're doing is they're the middleman. They're taking money from the investors, from the private individuals, and they're giving it to the businesses. Okay. Now, why do they exist and why are they making so much money? You know, what advantages do they offer? So the advantages of financial intermediaries is their ability to pool resources. So what this means is by pooling resources of many small investors, they are able to lend considerable sums to large borrowers or they're able to buy some really cool assets. One of the cool assets that they do are things like shopping centres. Shopping centres are very popular here in South Africa. The thing is a shopping centre costs a couple of hundreds of millions of rends to build. And, you know, they're worth a lot, but they make a lot of money through rent and all those type of things. Now, as an individual, it's very difficult for you to have 100 million or so to come by a shopping centre. But if you, along with say 2,000 other people, give a bit of money to a financial intermediary, they can pool those resources and they can buy the shopping centre in their own name, take the rental income, take off a little bit of their fee and then give you that rental income. So they can pool resources to buy assets that would not have been accessible to the individual. Remember in the previous video when we were talking about households, we said we need to look at the characteristics of the assets available because shopping centres or some of these exotic assets will not be available to the individual man, but they will be available to a large financial intermediary. So, yeah, shopping centres. OK, the next thing is, is that these guys over here can also get a lot of diversification. OK, because let's say once you've pulled the resources, let's say you're a very rich individual, you might be able to buy one shopping centre. But by coming through a financial intermediary who's getting a lot of you wealthy individuals, they can maybe buy six or seven, maybe even 10 shopping centres around the country that have got different exposures to different markets and they can therefore offer you diversification. One way of thinking of it is as an individual, you can buy into these things known as REITs or into shares of property companies and there you can say put in 2000 RAND and have a 2000 RAND exposure to the property market and not just to one property, but to the entire property market. So you're getting all these lovely diversification benefits. OK, also because financial intermediaries are making a lot of money and because this is all that they do, they have a lot of expertise. So they have expertise because this is what they do all day and because they go and they take their fees and they employ actress and accountants who like I told you are the smartest people on earth. And because of that is they have a significant advantage when it comes to knowledge and understanding of the financial markets. The man on the street will know less about bonds and stock trading than say a big bank or a insurance company or an asset manager. Well, we should hope so. So they do offer expertise. And then the whole idea is that because if these guys get big enough through economies of scale, they can offer it at lower dealing administration and management costs. And I think maybe let's put that down to they make things a little bit simpler. So as an individual, if you want to buy shares on the stock market, there's quite a lot of forms you need to fill in or if you want to do this, we'll do that. You know, there's all this regulation by coming through a financial intermediary, they take care of that. And because they're doing it at such a large scale, there's economies of scale, lower dealing and administration costs. So these guys make a lot of money because they do offer. I mean, these are a lot of advantages. They pooling resources, they're doing offering diversification. There's expertise and, you know, they make the whole investment process simpler. But now what are the disadvantages? I mean, one of the key disadvantages is the asymmetry of risk. So what do I mean by the asymmetry? Am I spelling this word right? The asymmetry of risk. OK, the idea is that as an individual, I give this asset manager, this very smart asset manager, 100 grand. Here you go. Have 100 grand. And the idea is that he's going to take a fee of five grand and then he's going to take 10 percent of whatever earnings, whatever, you know, generation that he creates. So if he doubles the investment to say 200 grand, he's going to take a 20 grand fee for himself. OK, that's 10 percent. The problem is, is that let's say he goes. Well, what he decides to do then is he decides to go to the roulette table. OK, and he says, I'm going to put 100 grand on black and I'm going to spin. Because if I lose, OK, then I end up with five grand, and that's the fee of taking the money. If I win, I get the fee plus I get the 10 percent. So I'm actually getting 25 grand. So I'm going to take a risk where I get either five grand or 25 grand. Whereas an individual, what you're getting, what your risk payoff is, is if it comes off wrong, well, you get nothing. And if it comes out right, you're getting well, 25 minus 200. You're getting a hundred and seventy five. So maybe let me actually let me draw this matrix out a little bit better over here. So let's have the individual and we have the financial intermediary. OK. And let's say this is best case and this is worst case. And this is on a 50 50 risk investment. So best case is we get a hundred and seventy five. The worst case is we get zero. The financial intermediary best case is that they get 25. And the worst case is that they get five grand. Now, yes, it's better for the financial intermediary for to land on the right one. However, what this does is what it does is that it makes them take on more risk than they should because they think, listen here, guys, if we take on these risky investments, worst case scenario is we just get our five grand fee. The best case scenario is we getting, you know, 25 grand. That for them, there's not that much loss. There's not that much that much that there is not that much loss aversion. Whereas with the individual and also if the individual had taken on this 50 50 risk by themselves, they would have been looking at 200 versus zero as the payoff. So they're actually losing 25 round of that or they're giving it to the financial intermediary for playing blackjack or roulette or whatever like that. Yes, there are rules and regulations that say financial intermediaries cannot take investors money and gamble with it. You know, they will lose their license and there is regulation preventing that. But when it comes to, say, choosing stock A and stock B, stock A is a chocolate factory that's got very predictable sales, very predictable expenses. Or stock B, which is a genetically engineering company that does, you know, weird futuristic DNA stuff and they need a lot of capital for R&D and they're either going to make millions or they're going to go bankrupt tomorrow. So financial intermediaries might be encouraged or incentivised to take the riskier share because of the payoffs. So that that is the one downside is that people are making money of your money with none of the risk exposure like you have. And that's why I feel like all these things can be replaced in the future with artificial intelligence and blockchain technology. So blockchain technology will allow for some sort of cryptocurrency that allows for frictionless transactions which will allow money to be, you know, invested into one place and then, you know, sold and invested into another place with very, very small fees. And we can write artificial intelligence rules to say, OK, this company meets my risk appetite. Therefore, we're going to put shares, sorry, put capital behind that share. Or we're going to move capital to do that because you've now had a child, you have a dependency and all these various things like that. So I do have a very optimistic look on the future that we're not going to be relying too much on banks, insurance, pensions and collective investment vehicles and asset management because I feel like machines will be able to do that for us. It's just the regulations that are maybe holding that a bit back. But I do feel like we are going to be seeing this type of revolution or financial disruption very soon. But anyway, that's all I want to talk about with regards to financial intermediaries is they are a big play in the economic environment because they can pool all these resources and they are very intelligent with the expertise is they can, you know, what they're wanting in the stock market or what their moves are doing will cause the markets to change. So it is very important to understand what the financial intermediaries are doing and what their opinion is. And it's very easy to find that out by just subscribing to their newsletters and reading their chairman's report and seeing what their outlook is on the environment, specifically around economics. And if you can be a step or two ahead of them, there is opportunity for you to make money in the asset trading game. But anyway, that's all we have time for. In the next video, I am going to be looking at businesses and their role in the economic environment and what they do for money and investment banks and all that type of stuff. So that's going to come out tomorrow. So hit subscribe to check out that video. Thanks, guys.